Although US stocks have been on a tear lately, professional investors aren’t getting too excited.
The S&P 500’s rally to record highs in late January has been met with skepticism by Wall Street, according to Bank of America. That could be a reason for caution — or a sign that stocks have more room to run.
BofA strategists gauge the mood in markets using the firm’s sell-side indicator, which measures how bullish or bearish sentiment is and then issues a contrarian investing recommendation. An elevated reading on the SSI suggests that professional investors advise shifting toward stocks — a sign of excessive optimism that warrants selling. Naturally, the inverse is also true.
In January, BofA’s sell-side indicator remained decisively in neutral territory. It fell modestly after back-to-back months of better sentiment but was in line with its 15-year average. The latest reading implies that balanced fund managers should keep just over half of their assets in stocks.
Bank of America
So while stocks have gained momentum recently, Bank of America’s data shows that bullish sentiment is far from over the moon.
“With consensus expecting a soft landing, investors are increasingly concerned that there are no bears left on Wall Street,” wrote Savita Subramanian, BofA’s top equity and quantitative strategist, in a February 1 note. “Although bearish sentiment may not provide the tailwind to equities that it did last year, sentiment has not risen to levels of euphoria that we typically see at the end of bull markets.”
Following the SSI tends to pay off over time. When the indicator is at current levels or lower, the S&P 500 rises an astounding 94% of the time in the next 12 months compared to 81% normally, according to Bank of America. In that scenario, the firm noted that its median return is 20%.
Bank of America
And while the SSI’s predictive ability is less powerful with a neutral reading, Subramanian wrote that the indicator’s current level implies that US stocks will climb about 14% in the next year.
Even though the SSI is waving the green flag, stocks still face serious risks. Subramanian cited concerns about China’s economy, geopolitical unrest, and the uncertain path of interest rate cuts as reasons to stay wary.
Professional investors are taking those threats to heart. In late January, Bank of America strategist Ohsung Kwon found that hedge funds are leaning toward defensive stocks relative to their economically sensitive peers at one of the highest rates over a decade.
Bank of America
20 stocks that hedge funds love
A market where investors are neither overly optimistic nor too pessimistic makes for a “stock pickers’ paradise,” Kwon wrote.
Hedge fund managers are on edge, judging by their tilt toward defensive stocks, but an analysis of their long positions in 13F filings reveals that they still see plenty of worthwhile investments.
Below are 20 stocks that hedge funds are overweight most relative to the S&P 500, according to Bank of America. Along with each is its ticker, market capitalization, sector, and net relative weight in hedge funds versus the index.
