Why investors hate this bull market

0:06Pushkin. In principle, these should be happy days for US investors. stocks are up 20%, more than 20%. If you just look at the S &P 500, things are going great. But, and it's a big but, a lot of that is driven by just seven stocks, all in the technology sector and exposed to artificial intelligence. The market's narrow. It's a skinny market. And that puts investors in a bit of a weird position, makes them a little bit nervous. Today on the show, we're going to look at reasons investors hate this rally and why there's just a handful that believe the bear market is over. This is Unhedged, the new markets and finance show from the Financial Times and Pushkin.

0:47I'm reporter Ethan Wu here in the New York studio, joined as ever on Tuesdays by FT Markets editor Katie Martin. Katie, you've been writing about this. Do we have an official name for these seven stocks? This seems like an important consideration. There's some debate here. I'm going to go with Magnificent Seven. Salubrious 7? I feel like that's a little too cumbersome. I mean, Sexy 7? Maybe that's a little snappier? I don't know. I don't know. Listeners should write in and tell us what they think the 7 should be called. Can you, Katie Martin, name the Salubrious 7 stock? Yes, because I've got them written down in front of me.

1:20Okay. Yeah, so we are here talking about the real kind of big dogs of the US stock market this year. They are Apple, Microsoft, Alphabet, Amazon, Tesla, Meta. enter stage right. NVIDIA could come from nowhere to be a trillion dollar company. And first of all, these things are enormous. They have a market cap that's about a quarter of the entire index between them. And then also they are up each of them somewhere between 40 and 180 percent so far this year. That's NVIDIA. NVIDIA, wow. You know, this is some scorching stuff. And so they are big enough and the rallies are large enough. This is just like pulling the entire index out of whack.

2:01And so on the one hand, you've got an index that's saying, look at me, I'm up 16, whatever percent so far this year, everything's well in the world. But then you've also got all investors everywhere saying, you know, I don't know, I feel like there's a recession coming. This is really bad. We just had a banking crisis, yada, yada. So there's this really kind of squidgy zone going on in markets when no one knows whether to be happy or sad about them. You mentioned a lot of the reasons people are hating this, right? It's not clear what the implications of AI tech is going to be. Is this something that's accretive to these big tech companies or are they just going to have to spend to keep up their current competitive positions?

2:38And maybe it doesn't actually give them any advantage. That's unclear. Market narratives and new technologies tend not to mix that well. Investors are not the best assessors of the promise of a new technology. And then there's this whole question of recession, which we talked about in the podcast last week. There are lots of very potent indicators saying that recession is coming. The classic indicator of recession, the inverted yield curve, when short-term interest rates are higher than longer-term interest rates, this has never been wrong in history at calling the next recession. And it's been inverted for about a year now.

3:11It feels hard to buy into a period of market optimism when you have indicators like that and when it's just so narrow. The yield curve, the yield curve. Could it be wrong this time? I mean, it's never been wrong before on the particular metric that you're thinking of, but that doesn't mean it can't be wrong in future. But if you look at some of the just the scale of what's happening with some of these tech stocks, right? So Nvidia has added$640 billion in market cap this year. That's like you take an entire JP Morgan, and you add in an entire Bank of America. And that's what Nvidia has added this year.

3:47Any rational person would look at this and think this is just kind of bonkers. But is it bonkers? Is Nvidia going to take over the world? Has it got like a moat around its business that means that nobody else can do this AI technology in the way that NVIDIA is doing it. But also, what's to say that the rest of the stock market can't catch up, right? What if the sort of AI technology that NVIDIA is working on is going to be such a massive productivity boost and effectively earnings boost to every country, every company on the planet, that the rest of the market kind of catches up? So this is the big debate.

4:21Are the magnificent slash sexy seven going to crash down and meet the rest of the market halfway? Or is the rest of the market going to catch up with the sexy seven? I don't know the answer to this. If I did, I'd be running a hedge fund somewhere and making lots of money. But that's the really big debate. And, you know, is it really possible for the rest of the market to play catch up in that environment where you've got signals from the bond market saying, ooh, you know, dark clouds ahead, be careful. And when you've got everybody expecting a recession, whether it's a soft recession or a hard recession on the other side.

4:55So very, very difficult situation to read here. And that's why you have got this disconnect between, you know, index saying everything is well in the world and human investors saying, I don't like this one little bit. But, you know, there are reasons to think maybe we should respect this rally. There are certainly people that do. There are certainly people that look at this and say, well, you know, it's not our favorite rally of all time, but it's got some legs to it. There's something really happening here. And there's also kind of a self-perpetuating logic of a market rally. I think it's important to remember because we've just been through 2022, one of the ugliest years in the stock market in a while.

5:34Markets go up most of the time, right? And - It's just the past couple of years that has traumatized us. It's been the exception recently. I mean, markets tend to go up in the long term. They go up. The S &P rise is something like 8 % on average every year in the long sweep of history. And, you know, this creates certain incentives for fund managers, right? Some fund managers operate on a pretty short-term basis. They're supposed to match or beat the market on, you know, maybe a four-quarter basis, maybe a little bit longer. But you don't want to be lagging it if you're a professional fund manager.

6:04And whatever the reasons for the rally, whatever idiosyncrasies are driving stocks up, if stocks are going up and you have to tell the people that write your paychecks, yeah, I don't really trust this rally. I have an uncomfortable emotional relationship with this rally. Therefore, I've returned 0 % on your money this quarter while the market's up 5%, 10%, 20%. You don't look so good. No. Why don't I just replace you with some AI or a nice index tracker that'll cost me the best part of nothing? That's one of the theories here as to why actually the rest of the market could be just gearing up to play catch up.

6:39I was reading a note from HSBC the other day, and they were talking about what we call real money accounts, right? So that's the really big investors, not just like little hedge funds or individuals or whatever, but pension funds, insurance companies, like really big asset allocators. They are still bearish. They are still nervous about the market. Their positioning, you know, the sorts of assets that they're buying and selling tell you that they are not all in on this rally yet. And these tend to be quite slow-moving investment houses because they are so big. At what point do they throw in the towel?

7:11At what point do they have that conversation that you were just talking about with their boss? You know, the fund managers there are hauled into a meeting and asked, why are you lagging so behind the market? And it's exactly that. When do they throw in the towel? And that's why HSBC, at least, is saying, we think this rally's got further to go because we think that some of this kind of negativity is going to have to fall by the wayside. Because this is something that fund managers always kind of say is it's not our job to be right. It's our job to make money. And I think I'd make a cut here between rally chasers on the one hand, which I think right now you have some discretionary investors.

7:46I saw from Deutsche Bank this morning, some discretionary investors that have a little more leeway are starting to buy the rally and some of the slower moving real money investors you're talking about. Maybe they'll play catch up. I'd call that general bucket of investors, you know, maybe rally chasers. They're not true believers. On the other hand, you do have the true believers, people who look at some type of corporate fundamentals or some market dynamics and say, no, I believe this for real. And we wrote a bit about Bank of America's equity strategy team. They have been making the bull case for a while now.

8:17And their view is kind of that we're pivoting toward an era where companies are going to have to focus on efficiency. You know, we got higher interest rates. We got higher labor costs. Companies are doubling down on profitability, returning cash to shareholders. And we've seen this with companies like, you know, you mentioned Meta a while ago. They've had a pretty remarkable pivot. it. They've gone from growth mode to, you know, we're going to try to grow on the metaverse and some AI stuff, but we're also going to focus now on efficiency and returning cash to investors. You're seeing this kind of across the stock market and Bank of America thinks, well, that's the setup for the next bull market is a change in how companies are run.

8:54And, you know, she sees AI as kind of the leading edge of that because we have this, you know, potentially new emerging technology that could improve productivity. Maybe, maybe not, but that's the first leg. and there will be more to follow and it's for real. I would not call that the majority. I still think that's a bit of a fringe opinion right now, but these things have a way of starting fringe and then becoming mainstream pretty quickly. Yeah. And I think if this ends up being a year with the most hated rally of all time, then we're going to see a lot of fund managers out there underperforming relative to their benchmarks.

9:26And they're going to have some awkward conversations to have with their clients and with their bosses towards the end of this year. But it's quite hard to call to mind another occasion when the markets have been up this much and everyone has been so blooming miserable about it. Yeah. So we've talked about why everyone hates this rally. We've talked about why some people are buying into it, either because of true belief or because they have to meet their benchmarks. But Katie, we should talk about how we feel, not like we have some crystal ball into how this all ends. But I mean, I'll just say for my part, and I'd love to here if you disagree with me.

10:00I don't really buy it, but I think you could have a temporary reprieve. That seems to me the most likely outcome is that we have an end to the bear market. We have stocks trading flat to up for a couple of months just because the economy, as we talked about last week on the podcast, has been so resilient. Economic resilience is not an abstract thing. That translates directly into higher sales, fatter margins, bigger profits for companies, And that drives share performance. I think an extended period, a couple quarters of economic resilience driving profits resilience, that can keep markets going for some time.

10:35Now, I think the yield curve we talked about earlier, the recession risk on the horizon, both of us think recession's coming at some point next year, I think a little earlier, maybe in the first quarter. If that's the case, this bull market's not lasting long, but it could last for a little bit. And in the meantime, you'll have people that need to chase. I feel like the bears, you know, the pessimists are kind of all out of ammo. Interesting. You know what I mean? Like, what is it that could really be a negative shock here? You've had a massive part of your banking system in the US go into distress.

11:08We seem to have got through that okay. We've had five percentage points or more of US interest rate rises. System seems to be kind of holding, what is it? What's the catalyst for something terrible to happen? Unless there is some sort of train wreck heading for one of these stocks that's been propping up the market so far this year that we just can't see coming, then I find it difficult to see what can knock this off course. Also, it's the most annoying potential outcome. So that, you know, on the basis that annoying things always happen, then I guess that's what we've got. So Katie Martin, you love this hated rally.

11:47It's a rally only Katie Martin could love. I'm not sure I go that far, but I respect it. I'm begrudgingly sort of starting to respect it. Okay. Okay. We've got a rally respecter. All right. We'll be back in a moment with Long Short.

12:16This is long, short, that part of the show where we go long and short, one company, stock, museum. I don't know. I didn't have a third thing today. Whatever it is. Today, Katie, I am long lettuce. Nice. You'll know what I'm talking about. UK listeners will know what I'm talking about. US listeners, just for you, this is referring to, you know, when Liz Truss, former UK prime minister, was in office for a brief stint and the whole thing was kind of on thin ice the entire time. The Daily Star had a live stream of a head of lettuce with Liz Truss's hair on it with the question, which will survive longer, Liz Truss or the lettuce and the lettuce one?

12:52And it seems that it won not only in that context, but it's also done some lasting emotional damage to Liz Truss. She gave an interview to the UK press today where she described it as puerile. She said, I don't think it's funny. And my question for Liz is, I mean, come on, has no one taught you? You got to steer into the skid with these sorts of things, right? You can't put up that much of a fight. I am long lettuce. Yeah, not to be a complete pedant here, but she was actually speaking to Irish Radio a couple of days ago, but the point still stands. She has been bested by a lettuce joke, and she has failed to see the funny side of it.

13:26So, no, I think being long lettuce is a pretty good trade. I know it's really bad to also be long something because we're supposed to be long something and short something. So the format here is all kind of skew-iff, but I'm going to be long UK government bonds. they now yield an enormous amount. The yield on a two-year gilt is 5%. On a 10-year you get 4.4%. Now the last time yields were up at these sorts of levels it was because of a crash in prices that came about when Liz Truss nuked the UK financial system with her poorly named mini-budget. The same thing is not happening here. We haven't gone to like 5 % on the two-year in a straight line.

14:05This has kind of been creeping up because of a massive recalibration of what the market thinks the Bank of England is going to have to do next, which is keep on raising interest rates until Katie Martin can't afford her mortgage anymore. And so we've suddenly got to the point where there are some really juicy yields available on UK government bonds, highest yields since about 2008 in some cases. And lots of fund managers and retail investors are suddenly sniffing around and saying, hmm, 5 % on a two year, you say, I'll have a bit of that. I don't think the UK is going to default. So thanks very much.

14:37And that's very much the hot topic in UK markets at the moment. Katie, this is the second Tuesday episode in a row that we've gone double long. And actually, one reader wrote in to point out that a double long is called a Texas hedge, where a cattle rancher is also long cattle futures. So they're kind of double risk exposed to cattle. If you, listener, have any creative trades that we should do in the long short section, please email me E-T-H-A-N dot W-U at FT dot com. All right, Katie, thanks so much for being here. We'll have you back on Tuesday. And listeners, we'll be back in your feed this Thursday.

15:12Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, John Schnarz, Eric Sandler, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free, and a 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.

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