Market Updates
What is the role of fear and greed in the market and why major banks remain wary of the up trend?
What is the role of fear and greed in the market and why major banks remain wary of the up trend?
The recent surge in stock prices, resembling a rocketship, was not predicted by major investment banks. Despite this unexpected turn of events, these banks have not altered their projections for the year. However, this sudden surge has caught the attention of investors, as evidenced by the fear and greed index indicating an excess of greed. Therefore, let's examine the ongoing rally, the perspective of the big banks, and its impact on your investment portfolio.
What have the major investment banks been communicating?
Regarding the unexpected growth in stock prices at the start of the year, the big investment banks were caught off guard. Nevertheless, they remain vigilant in their outlook. At the close of 2022, most big banks were discussing the possibility of value in both corporate and government bonds following their steep decline, but few expressed positivity towards stocks. The consensus among them was for an economic recession in the US, persistent inflation, and high interest rates - a bleak picture for the stock market.
As for their projections for the end of 2023, the S&P 500 forecasts among Wall Street's big banks varied, from BNP Paribas' low estimate of 3,400 to Deutsche Bank's high estimate of 4,500, with most other banks clustered around the 4,000 mark. This is below the current level, suggesting that they are still somewhat cautious about the remainder of the year.
Recently, Goldman Sachs updated its S&P 500 forecast, increasing its three-month prediction to 4,000 (up from 3,600), due to improved global growth, declining inflation, and growing expectations of a "soft landing". However, Goldman did not change its year-end prediction of 4,000, as it believes the recovery has already been factored into US stock prices. The bank has instead shifted its focus to non-US stocks, credit, and cash, which it believes offer superior returns with lower risk.
On the other hand, strategists at Bank of America, Morgan Stanley, and JPMorgan continue to be wary of the outlook for the US stock market. A six-week rally does not necessarily alter their year-end targets, but their projections of a selloff in the first quarter appear to be off the mark at present.
Furthermore, a recent Wall Street Journal survey revealed that over 65% of forecasters still anticipate a US recession within the next 12 months. If this majority proves to be incorrect, it could trigger another rally, in addition to the one we are currently witnessing.
What are the factors behind the ongoing surge in stock prices?
The fluctuation in stock prices is influenced by a multitude of elements. Over the long-term, core factors like free cash flow hold significant sway, but in the short-term, stock prices can be more unpredictable and changes in investor sentiment and market positioning can have a greater impact. Currently, it appears that this is the case, as the "fear and greed index" by CNN has shown that investor sentiment has reached a level of "extreme greed."
CNN's "fear and greed index" comprises of seven measurements, each rated on a scale from 0 to 100, and at present, four of these components - stock price strength, stock price breadth, options trading, and demand for safe assets - are pointing to a state of "extreme greed." This sudden change, observed only within the past month, could suggest that investors may choose to sell their stocks and realize profits in the near future.
The Nasdaq and S&P 500 have both seen notable gains this year, with an increase of 14% and 7.7% respectively, but these figures do not fully capture the extent of the stock movements. Goldman Sachs reports that its technology stocks have risen by 33% and its retail stocks by 50%.
The sudden rise in stock prices has taken many market players by surprise, resulting in hedge funds and others having to buy stocks to cover their short positions as prices increase, a phenomenon known as a "short squeeze."
What is the future outlook?
What determines the future direction of the economy and the stock market mostly hinges on the actions of the Federal Reserve.
In response to the COVID-19 pandemic, the Fed swiftly lowered its key interest rate to near zero, but to provide further support, it started buying government bonds and mortgage-backed securities, which is known as quantitative easing (QE). This caused the size of the Fed's balance sheet to grow from $4 trillion to $9 trillion at the start of 2022.
While the exact effect of QE on the economy is debated, most agree that it leads to a rise in other assets like stocks and real estate. A correlation between the size of the Fed's balance sheet and the level of the S&P 500 can be observed in the chart.
Since mid-2022, the Federal Reserve has been gradually reducing the size of its balance sheet through a process known as quantitative tightening (QT). The Fed had increased the size of its balance sheet through its quantitative easing (QE) policy, in response to the economic fallout from the pandemic. However, as the economy recovered, the Fed began reducing its balance sheet, first by $45 billion per month and later by $90 billion per month.
It is expected that the Fed's balance sheet will be around $7.5 trillion by the end of 2023, which is a significant reduction from its previous size of $9 trillion at the start of 2022.
Some experts believe that there is a correlation between the size of the Fed's balance sheet and asset prices, including stocks, and that a Fed balance sheet size of $7.5 trillion would result in an S&P 500 level of around 4,118, which is where it currently stands.
What's the potential for gain?
