Wall Street Has Almost Never Been This Pessimistic

We’re now seven weeks into the fourth quarter and US equities have gained in six of them.

Cautious soundbites, ostensibly plausible near-term bear cases and dour prognostications of various sorts have all come to naught.

Robust earnings, a resilient US consumer, policy accommodation and a lack of alternatives for trillions in sidelined cash, have all helped bolster stocks, despite elevated valuations and narratives about “peak” this and “peak that.” Equity allocations have rarely been higher. And investors prefer US shares despite a yawning valuation gap with the rest of the world.

“Clients [are] ending 2021 ‘risk-on’ via the biggest Overweight of US stocks since August 2013, convinced inflation is transitory and expecting the Fed to remain well behind the curve,” BofA’s Michael Hartnett wrote, in the November installment of the bank’s closely-watched Global Fund Manager survey.

The light blue bars in the figure (above, from BofA) illustrate the Overweight. The last time survey participants were net Underweight US shares was early 2019.

Morgan Stanley expects European and Japanese shares to outperform in 2022. The bank’s Mike Wilson also sees the S&P ending next year lower than it is now (table below, from Morgan).

US underperformance is rare if you’re prone to recency bias. But pre-GFC, it wouldn’t have seemed quite so anomalous.

Wilson isn’t alone when it comes to being skeptical about the prospects for continued buoyancy in US equities. Strategists see the S&P ending 2022 at 4,840 on average. That suggests just a 3% gain from Friday’s close and it’s among the most pessimistic outlooks from Wall Street on US shares in more than 20 years (figure below).

Not everyone who’s wary is convinced of Fed hikes. Indeed, Morgan Stanley doesn’t see liftoff in the US until 2023. Rather, the bank suggested a shift in the macro backdrop might undermine US leadership to the extent perennial favorites have trouble digesting a transition away from the “slow-flation” environment which favored the secular growth heavyweights that dominate US benchmarks. Margin erosion is also a concern.

If you ask BofA’s Hartnett, 2022 will be defined by a “rates shock.” “Financial conditions are set to tighten via Wall Street and/or policy action,” he said. “Asset prices are always driven by two simple things: Rates and profits.”

He said short rates will keep rising and suggested the curve might invert. Earnings, he warned, will “slow sharply” (figure above, from BofA).

61% of those polled for BofA’s fund manager survey still say inflation is transitory and just 10% expect the Fed to hike in the first half. Note that in order to believe in liftoff before July, you’d have to posit an accelerated taper or simultaneous tapering and rate hikes. The former is plausible (likely, even), the latter not so much.

Hartnett sees “low and volatile” asset returns next year. To be sure, not much is cheap (figure below).

Lackluster performance for bonds and credit haven’t produced any bargains.

Still, investors aren’t necessarily on board with any pessimism towards US equities. 30% of the nearly 400 panelists in the BofA survey said the S&P will produce the best returns next year. 34% said emerging market shares.

As for the balance of 2021, Nomura’s Charlie McElligott wrote Friday that we’ve “now transitioned into the bullish segment of the seasonal after having cleared the mid-November traditional weekly lull.”

Although he delivered the customary recap of the post-OpEx vol expansion window, McElligott noted that history suggests “returns this week through year-end [are] ‘risk-on,’ with a pro-cyclical tilt.”