The VIX, which measures market volatility, is currently at 20, indicating a significant level of uncertainty. Stocks are on the verge of experiencing their worst October performance in five years, and the bond market seems to be constantly turbulent.
For those who typically invest in stocks and are used to taking advantage of market dips, the current situation is becoming overwhelming. Investors from various backgrounds are withdrawing their investments and adopting a more defensive approach, which is the most cautious we’ve seen in over a year by some measures.
Surveys of professional money managers reveal that large institutional investors have reduced their holdings in stocks to levels not seen since the depths of the 2022 bear market. Hedge funds have been increasing their bets against individual stocks for 11 consecutive weeks. Various models that analyze investor positioning indicate that everyone, from mutual funds to algorithm-driven quant funds, is significantly reducing their exposure to stocks, which is well below their long-term averages.
Market timing is often criticized in the world of trading, but it still happens, especially when the markets are stressed. As we enter November, a big question looms: Is the recent mass departure of investors from the market a sign that a recovery is on the horizon, or are we in for a prolonged period of challenges?
Doug Ramsey, the chief investment officer at the Leuthold Group, expresses his concern that despite the deep setbacks in the current market, there hasn’t been much improvement in investor sentiment. He describes how the cautious outlook that prevailed during much of the 2023 market activity has transformed into a more hopeful perspective, which he calls a ‘slope of hope.
It’s been challenging to find investors willing to buy the dips lately. In October, the S&P 500 has dropped by over 1% on five separate occasions, pushing it into what’s known as a correction. The Nasdaq 100 Index, which measures tech stocks, is also experiencing high levels of expected price swings, similar to what we saw back in March. Even though the tech sector received some positive news on Friday with strong earnings reports from Amazon.com Inc. and Intel Corp., the Nasdaq 100 had its worst two-week decline this year and is on track for its most significant October drop since 2018.
A survey conducted by the National Association of Active Investment Managers indicates that money managers are reducing their investments to levels similar to what we saw in October 2022. When we look at equity investments, they have dropped below the usual levels for most types of investors, especially hedge funds and mutual funds, based on analysis of data from the Commodity Futures Trading Commission conducted by Barclays Plc.
Professional speculators have been increasing their short positions for nearly three months, which is the longest such streak on record, according to Goldman Sachs Group Inc.’s prime brokerage.
The Cboe Volatility Index, often referred to as Wall Street’s “fear gauge,” has remained above 20 for the second consecutive week, even after staying below this level for more than 100 days. Bond market volatility has given investors more reasons to be concerned, as we’ve seen significant fluctuations in interest rates, with movements of more than 10 basis points on Wednesday and Thursday. This added pressure to an earnings season where companies that miss their profit estimates are being hit hard.
Yields on bonds have increased significantly in the past six months, which means that the stock market will likely need to decrease to reach valuations that are more in line with historical norms,” explained Matt Maley, who is the chief market strategist at Miller Tabak & Co. He pointed out, “The key concern here is the substantial gap that has emerged between the bond market and the stock market.
From a different perspective, all the negativity in the market can actually be a good sign. It indicates that there might be hidden buying power waiting to emerge if the sentiment changes. Some experts believe this shift is on the horizon. They’ve noticed that significant turnarounds in the stock market often align with changes in how both institutions and individual investors are positioning themselves. In the past, when investors reduced their optimistic bets, the market saw gains, and when there were buying frenzies, it often led to declines.
Strategists at Barclays have pointed out that reduced exposure to stocks, positive technical indicators, and seasonal factors are increasing the likelihood of a year-end rally. This message aligns with what Bank of America Corp. and Deutsche Bank AG have mentioned before.
Callie Cox at eToro emphasized, “Fear may be uncomfortable, but it’s a healthy part of how markets work. If investors are prepared for the worst, they’re less likely to panic and sell everything if negative news arises.”
It’s important to understand that predicting exactly when the market will change direction is extremely difficult. Right now, investors are processing the Federal Reserve’s message that interest rates will stay elevated for a while, and important indicators of inflation still show some activity. Given this, the negative mood in the market might actually be justified.
The Federal Reserve is also rapidly reducing its holdings of government bonds, and this puts pressure on investors who are trying to figure out how high interest rates might go.
Peter van Dooijeweert, who leads the defensive and tactical alpha team at Man Group, pointed out, “The message that interest rates will stay high for a while and the recent signs of inflation suggest that bonds may not stabilize anytime soon. This could lead to continued weakness in the stock market, especially if corporate earnings disappoint.”
