In a World Full of Risk, Stocks Look Like the Least-Bad Option

(Bloomberg) -- Whatever hardships are afflicting global stock investors, it's worse in other markets, and that alone may be enough to keep the equity rebound going for now.

Stocks recovered in record time from the initial shock of the war in Ukraine and the havoc it's wreaked on global commodity supplies. That followed their resistance to successive waves of the coronavirus pandemic since 2020. Now, they're refusing to be undone by ominous portents in bond markets that a global recession is on the horizon.

Part of the latest resilience is down to a hard-to-shake “buy the dip” pattern in trading. But the wall of worry that stocks have to climb right now is getting higher and higher as rampant inflation squeezes demand, economic growth slows and central banks look to finally end the era of excessively loose monetary policy.

While all that means corporate profits are poised to take a hit, stocks may still have a case, not least because the alternative options are scarce.

“With cash and bonds offering negative real yields, investors are still inclined to buy the dips in global equities, despite deteriorating fundamentals,” Citigroup Inc. strategists led by Robert Buckland wrote in a note on Friday.

The rebound in March backs up that view. While the first quarter was the worst for global stocks since the outbreak of the pandemic, last month actually saw a recovery. In fact, a gauge of volatility in euro-area large caps shows that the war-induced slump is proving so far the shortest market rout this century.

Apple Inc. just had its longest winning steak in almost 20 years, and U.S. stocks gained almost than 10% in the second half of March. Even in Europe, epicenter of the geopolitical crisis, the Stoxx 600 has recouped the initial losses suffered after Russia's invasion of Ukraine.

“Bull markets don't go quietly. After all, they've come back from many other crises over the past few years,” said Chris Beauchamp, chief market analyst at IG Group in London. “Old habits die hard too -- ‘buy the dip' might be mocked quite a bit, but it is a sound strategy.”

Bond Losses

Some of the rebound is down to the recent rout in the world's other major asset class. The inflation spike, and the tightening push by central banks increasingly anxious to tame it, triggered a run from bonds.

Inflation is also eating away bank deposits, and mortgage rates are rising, leaving fewer places to allocate money.

“The first quarter was a challenging quarter for stocks, but more so for bonds,” said Marija Veitmane, a senior strategist at State Street Global Markets. “If you are an absolute investor, you need to put money somewhere, and stocks to my mind look at lot safer than other asset classes.”

Retail traders may also be playing a part in the latest gains. Options markets suggest at-home traders, who helped fuel last year's ferocious equity rally, are back and buying. A key measure of call volumes on 23 retail meme story is rising to levels reminiscent of previous speculative bubbles.

Another force is more technical and less influenced by worrying global headlines about Ukraine and commodities. Market players such as so-called risk parity funds or managed futures accounts have poured money into the market as they re-adjust their position amid the price gains and reduction in volatility.

“Systematic strategy covering of shorts and re-allocation of longs has meant a powerful buy impulse after the biblical de-leveraging experienced over the past six-month period,” said Charlie McElligott, managing director of cross-asset strategy at Nomura.

He estimates such players bought more than $61 billion in equity futures over the past month.

Curve Inversion

When it comes to the negative economic signals, strategists at JPMorgan Chase & Co. are among those reassuring that the recent inversion in the U.S. Treasury yield curve doesn't spell imminent trouble. Even if the portents ultimately prove correct, it's usually with a long lag, and Barclays Plc points out equities typically rise in the intervening period.

Among the reasons that investors discount the idea of a near-term slump are strong employment numbers in the U.S. There's also consumers' pandemic savings cushion and solid corporate balance sheets to fund buybacks.

Meanwhile, the energy-price shock after the invasion has eased. Europe's reluctance to impose sanctions on Russia's energy sector and a planned release from U.S. reserves, have helped alleviate the crunch, lowering prices back to around $100 a barrel.

For those convinced that the rebound has legs, the question is what to buy.

Philippe Jabre, founder of Jabre Captial Partners, says his multi-asset hedge fund is focusing on stocks with exposure to commodities, and financials.

UBS Global Wealth Management sees opportunities in energy, food, data and climate -- sectors set to benefit from a renewed focus on security and stability. For Goldman's team, instead of playing specific styles such as growth versus value, investors must look for individual companies “that can innovate, disrupt, enable and adapt” and focus on margins.

Still, both say that for the broader market, the upside is limited. Bank of America Corp.'s team has even warned the recent rebound is a bear-market trap.

Barry Norris, who runs Argonaut Capital Partners, a hedge fund, agrees, saying the rally is lifting a lot of stocks “where fundamentals are deteriorating further and there's no valuation support.”

“We are at the early stages of this bear market, we will see new lows over the summer,” he said.