New York - If you're waiting for the next meltdown in US
stocks or in commodities, you may want to get over it.
After several false dawns following the global financial
crisis, more investors are starting to believe the current rally in stocks,
commodities and emerging markets could be a long-lasting one.
The S&P 500 closed above 1 400 points last week for the
first time since the 2008 financial crisis. Investors piled into US equity
funds, with the biggest weekly inflows since mid-September.
"Is this risk rally for real? I think the answer to
that question is yes, but it's not a straight line up," said Art Steinmetz,
chief investment officer at Oppenheimer Funds in New York, managing more than
$177bn in assets.
Oppenheimer is currently betting on stocks tied to upswings
in the economy, and is also overweight in riskier bond classes, he said.
Since its recent bottom in early October, the S&P index
has jumped 30%. But for the first time since 2007, investors are not using the
gains as an opportunity to take profits and run away.
Instead, the rally has been slow and steady, and investors
see the sustained improvement in the US economy as a sign that demand has
returned and that risky assets can support higher valuations.
"The prospects for future returns in equities relative
to bonds are as good as they have been in a generation," Goldman Sachs
said in a note on Wednesday.
Dean Junkans, chief investment officer at Wells Fargo
Advisors and Wells Fargo Private Bank, said individual investors have started
wading back into higher-risk, higher-yield assets, including high-yield and
emerging market funds.
"For the last five years, few people wanted to talk
about a long-term plan," said Junkans, who oversees $1.3 trillion in
assets. Instead, investors had preferred the safety of low-yielding Treasury
bills and money market funds.
"Now I'd say they are dipping their toes back into the
market," he said, citing demand for high-dividend-yield stocks, high-yield
corporate debt, and emerging market fixed income.
How risky assets have performed
Last year was one for the risk averse: US government bonds
were the best-performing asset class. This year has been the reverse.
The S&P is already up 11% in 2012. The Thomson
Reuters-Jefferies commodity index has gained 2.4% so far in 2012 after losing
more than 8% last year. Long-dated US Treasuries prices, meanwhile, are down
7.3% this year, according to Barclays Capital.
The euro, at the epicentre of the financial crisis, is also
up nearly 2% against the dollar in 2012 after losses of 3.2% in 2011.
"There has been very substantial progress in the
eurozone the last couple of months,” said Thomas Stolper, chief currency
strategist at Goldman Sachs in London. He expects the euro to hit $1.38 over
the next six months and $1.45 by the end of 2012.
The eurozone's general stability is reflected in currency
options as well. Implied volatility has fallen to levels not seen since before
the eurozone debt crisis, in large part because heavily indebted Greece finally
agreed to a bailout plan and debt restructuring and the European Central Bank
(ECB) offered short-term loans to the region's banks.
The high-yield debt market has risen more than 5% this year,
according to Barclays Capital. Investors have flocked to junk bond
exchange-traded funds (ETFs), with the two largest junk bond ETFs attracting
nearly half of the $4.15bn that flowed into US fixed income in February.
Emerging markets have also become more popular; the Vanguard
MSCI Emerging Markets ETF pulled in $2.5bn while the iShares MSCI Emerging
Markets Index Fund hauled $1.5bn, according to IndexUniverse.com, which tracks
ETF performance.
Finding comfort in risk
The US stock market is a favourite of Scottish Widows
Investment Partnership. The fund, which is based in Edinburgh and manages about
$220bn, has made US stocks the biggest overweight sector in its portfolio.
"The recovery in the US has been more robust than
expected, and the rally in the US is probably more durable," said William
Low, head of global equities at Scottish Widows. The firm has exposure to US
industrials, information technology, and the consumer discretionary sector.
A key measure of risk suggests more investors are becoming
comfortable with equities as the rally has continued. The implied equity risk
premium, which compares the market's earnings yield - a ratio of earnings to
share price - to the yield on risk-free government debt, is what investors are
willing to pay to invest in stocks instead of bonds.
When it rises, it suggests investors want to be paid more to
take on the risk of owning stocks. When it falls, it suggests more comfort with
equities.
Over the last 10 years, risk premiums in both the United
States and Europe have been rising. Premiums peaked in August 2011 and have
since been declining, an indication that investors are more positive on the
outlook for stocks.
The implied risk premium currently suggests another 10 to
15% in gains in the US stock index this year, and for European equities, a
further 6-8% rise.
Scepticism still out there
It is easy to be skeptical about this year's gains. Risky
assets have gone through a series of rallies that were undermined by worries,
ranging from the eurozone's debt crisis to the Japanese earthquake and sluggish
performance from banks.
In Europe, while Greece has negotiated a bailout programme
and a debt restructuring agreement, investors question whether it will be the
end of the region's troubles. Other indebted nations like Spain and Portugal
loom as problems for Europe's banks.
Sabre-rattling between Iran and Israel has boosted crude
prices. Rising gasoline costs could pinch consumer budgets, and a greater
conflict would add uncertainty to markets.
In addition, recent data has rekindled fears that the
eurozone could fall back into recession. And signs of slowing growth in China
could carry risks around the world, particularly commodities-rich countries
from Latin America to Australia that have found a rich market in China for
their goods.
This year's strong rally has led some, like London-based
hedge fund GLC, to reduce their exposure to risk after profiting from
stockmarket gains and successful bets against bonds.
Nonetheless, Steven Bell, director and portfolio manager for GLC, which has about $1bn in assets under management, does not see a bear market coming.
"We're still on a positive track and in a bullish
trend," he said.
Other funds are taking advantage of low volatility to
increase hedges against calamitous events. The CBOE Market Volatility Index, or
VIX, Wall Street’s favored anxiety gauge, last week hit its lowest close since
mid-2007, suggesting benign market conditions will continue.
But later-dated volatility futures contracts show increased
concern that the market is starting to become complacent. Similarly, currency
market investors are also hedging against unforeseen outcomes. The concern is
that the euphoria will leave investors exposed to sudden, sharp declines.
Still, the market's worries are less intense when compared
with 2008, when Lehman Brothers collapsed, or the eurozone crisis that
dominated 2011.
"Markets love a grizzly story," said Simon Smollett, senior currency options strategist at Credit Agricole in London. "But there is no grizzly story. The bears have left the room."