The index has fallen from its strongest reading of the year to a neutral level, but the moderation does not reflect risk aversion. Instead, investors are showing confidence in equities amid resilient corporate earnings and expectations of central bank easing.
Marija Veitmane, head of equity research at State Street Markets, said October has been a strong month for stocks despite a mix of challenges.
“October has been a strong month for stocks, despite still high geo-political uncertainty in several major economies, mixed economic data (where one can get it, think US government shut down), and growing valuation concerns across a raft of risk assets,” Veitmane said.
“Global stocks (as measured by MSCI All Country World Index) have reached nine all-time highs during October. Strong earnings season clearly was a driver and helped to maintain the goldilocks narrative we are in: ‘the economy is strong enough to support robust corporate earnings, but weak enough to need rate cuts’.”
Veitmane said markets have grown more comfortable with the Federal Reserve’s easing cycle despite lingering inflation risks and labour market weakness.
“Valuation risks – however high – do not seem to worry equity investors either,” she said. “They continue to stay away from Value stocks in favour of Large Cap / Quality / Growth (aka Mag 7) – institutional investors allocation to Value stocks is currently at the lowest level since 2000. This is not surprising as Value strategies struggled for 20 years.”
She added that strong corporate earnings and the prospect of rate cuts have encouraged investors to keep increasing their equity holdings.
“The focus on robust corporate earnings and easing rate cycle is winning over valuation concerns, which has encouraged institutional investors to further increase their allocation to stocks to the highest level in 18 years.”
However, Veitmane noted that institutional investors are showing more caution within their portfolios.
“Notwithstanding this constructive risk backdrop, institutional investors are getting a little bit more cautious with their relative trades / intra-portfolio allocations. This has driven our Risk Appetite Index to a neutral reading,” she said.
“Within equities we have seen a shift in preferences from cyclical to defensive stocks, which was mostly driven by improving appetite for healthcare stocks. More importantly, institutional investors show unwavering support for all important technology sector.”
She added that technology-heavy Asian markets such as Korea and Taiwan have benefited from renewed buying, while Japanese equities have seen selling pressure following elections and concerns about inflation.
“In contrast, institutional investors sold Japanese stocks after the election reflecting concerns about the success of proposed reforms, given BOJ concerns about bubbling inflationary pressures.”
In foreign exchange markets, Veitmane said investors have begun to return to the US dollar.
“In the FX space we have seen tentative buying of USD during October from extreme underweight position. Dollar has historically been a safe haven currency though this was not the case earlier this year,” she said.
“It is interesting that institutional investors (particularly domestic ones) have been buying dollars as US government shut down. Buying dollars came in expense of selling EM FX as well as weaker FX Carry flows.”
Veitmane said dollar hedging by foreign investors remains limited, but could increase as hedging costs decline.
“Another important indicator we are watching in FX space is USD hedging. So far, we have seen only a small increase in hedging of US stocks by foreign investors. Perhaps, falling cost of hedging might encourage this trend going forward.”
