You know the market is frothy when the greatest concern among professional money managers is “Asset Bubbles.” As interest rates rose in the early part of this year, the ‘great rotation’ – with outflows out of bonds and in to stocks was heralded by many as ammo for the next leg higher in stocks.
However, with the recent slowdown in growth and collapse in interest rates, not surprisingly the rotation is perceived to be less likely this year. In fact, now over a quarter of investors – a share that rose 100% since BofAML’s previous (March) survey – believe it will never happen (only another 73% to get to reality).
Instead, there are increasing concerns about inflows leading to bubbles – mainly in high yield, where investors appear uncomfortable with flows-driven spread tightening without fundamental improvement and higher interest rates (and implicitly the linkage between equity valuations and credit bodes ill for the latter, as opposed to supportive).
In fact, asset bubbles now rank as the number one concern on investors’ minds, while a slow recovery moved up into second spot.
A full two-thirds of respondents believe credit markets to be overvalued and should we see fiduciary duty re-emerge and slowing demand (despite the inflows) into any and every ‘yieldy’ instrument, then just as in 2007, credit will be the first-mover (as it already appears to be) – credit anticipates, equity confirms.
So despite the best efforts of the ‘marketing’ arms of the big sell-side shops (so-called ‘strategists’), the professional buy-side (especially credit) is not ‘adding’ at these highs, but becoming increasingly skeptical.
And Via Barclays,
Signs of indigestion could cause investors to question whether the demand technical is really strong enough to justify the ongoing divergence between credit valuations and corporate fundamentals.
Looking at the deals being priced recently, several hallmarks of a market top are emerging. In the high yield space, we have seen a flurry of deals from low-rated issuers, from companies looking to return cash to equity holders, and in creditor-unfriendly formats (such as PIK-toggle notes). On the high grade side, peripherals have been able to issue unsecured, and even subordinated, debt. With central banks still active we expect markets to continue to grind tighter, but there remains the risk that economic data continue to disappoint and that valuations “catch down” to the hard data.
With that in mind, we think investors should be prepared to fade a significant further rally that is not accompanied by an improvement in the macro-economic backdrop.
As the chart below indicates (based on models fitting credit spreads to macro data and forward expectations) – credit is significantly ‘expensive’
Source: BofAML and Barclays