US stocks have broken to new record highs this week. The drivers of this rally, which Standard Chartered says it anticipated in its Outlook 2024 publication, are strong economic data, US Q4 earnings beats and robust global semiconductor demand. However, the indicator of investor diversity is signalling a high risk of reversal in key equity markets.
Given this, the bank believes it would be prudent for investors to trim their equity exposure. In a portfolio context, this would mean rebalancing allocations by reducing any excessive exposure to equities and averaging into safe havens such as US and European government bonds, where yields have turned more attractive after this year’s rebound. US short-duration inflation-protected bonds also look attractive as a hedge against the risk of any revival of inflation.
Strong earnings, economic data: The S&P500 index broke out of a major technical resistance, the record high of 2022. The key drivers: a) more than 80% of the S&P500 companies that have reported so far have beaten Q4 earnings estimates (upcoming technology sector earnings and their guidance for 2024 are likely crucial for the equity rally to sustain); b) stronger-than-expected business confidence data (PMIs) for January, which suggested manufacturing is seeing a recovery from last year’s recession and the services sector remains healthy (except for the Euro area); c) stronger-than-expected US GDP growth in Q4 2023; and d) strong forward guidance from TSMC, Taiwan’s leading global supplier of semiconductors.
Crowded investor positioning: However, SC says its investor diversity indicators (fractals) are flagging two-out-three chance of a reversal in Global, US, Europe, EM ex-Asia and India equities and DM High Yield bonds. Within equity sectors, the indicators are flagging high risk of a reversal in technology, communication services, financial, industrial and real estate sectors in both the US and Europe and the consumer discretionary sector in the US. Investor positioning also looks stretched across most of these markets.
Investment implications: The high risk of a near-term pullback makes it prudent for investors who are fully invested to trim exposure. Of course, this does not mean getting out of equities altogether. SC is to remain constructive on risk assets, especially with central banks poised to ease policy if growth and inflation continue their downtrend (as heard from the ECB this week and are likely to hear from the Fed next week). In a portfolio context, though, those overexposed to equities and HY bonds compared with their risk tolerance could use this opportunity to rebalance their allocations. Those who are still building allocations to equities and HY bonds can wait for and use any pullback to add exposure. The S&P500 index has near-term technical support at 4,740, followed by 4,550 and 4,400.
Hedging potential headwinds: Besides crowded positioning, we believe caution is warranted due to the following: a) robust US earnings estimates (11% y/y estimated for 2024, including 16% y/y for technology sector) leave little room for downside surprises; b) deteriorating underlying indicators of job markets, such as the rate of hiring, quits and permanent job losses (next week’s US jobs data in focus); c) recent escalation of conflicts on the Red Sea, if sustained, could lead to a revival in global inflation, denting the economic soft-landing narrative and delaying policy rate cuts. The bank believes US short-duration inflation-protected government bonds, gold and energy sector equities are attractive hedges against any revival of inflation.
Upturn in China: China equities are likely to see a near-term bounce on the back of the new support measures, but a sustained rally will need a more coordinated fiscal and monetary policy easing and a revival of business and consumer confidence. The Hang Seng index has strong technical support, having set a double-bottom pattern over the past year (14,794 and 14,597). However, the upside could be limited to 18,300 in the absence of large-scale and coordinated stimulus measures.
Bullish on EUR and JPY: In FX, SC remains bullish on the EUR and JPY over a 3-month horizon.
