Risk appetite is back with a bang.
Investment managers were in a buoyant mood at the World Economic Forum’s annual meeting in Davos, Switzerland, last week. In contrast to the previous three years, when Europe’s debt crisis dominated the meeting, most investors said the risk of a euro breakup has dramatically receded, if not disappeared. The turn-of-the-year agreement in Congress to avoid the fiscal cliff has left many people feeling better about Washington’s behavior and its impact on U.S. growth. And the high tide of global liquidity, with Japan now joining the U.S. and Europe in unprecedented monetary easing, has yield-hungry investors looking for ways to put their money to work, even if they think quantitative easing will end badly in the long run.
“The whole tone of everything has a lot more confidence,” said Mary Erdoes, CEO of J.P. Morgan Asset Management. “Black swan events are not things people are worrying about a lot.”
The clearest evidence of investors’ appetite for risk is the demand for alternatives. J.P. Morgan had record flows into alternative products in the second half of 2012 — about $1 billion a month — and the pace is continuing so far this year. “People are trying to catch up,” says Erdoes. “It’s a very positive sign. You don’t sign up for three-, five- or seven-year lockups unless you’re feeling confident.”
Scott Minerd, CIO of $160 billion-in-assets Guggenheim Partners, is certainly feeling confident. “I see opportunity all over the place,” he says. With U.S. employment growing at a steady if not spectacular pace and housing showing signs of recovery, the economy should grow at a pace of 2 to 3 percent this year and next, he says. Moreover, U.S. and European equities are cheap, he contends. Fed models indicate that U.S. stocks should be trading at 30 times earnings given today’s low interest rates, far above the actual market multiple of roughly 14.
One of Minerd’s top equity plays is bank stocks, which he predicts will “dramatically outperform” the market over the next five years. “They’ve been beaten down so hard,” he says. “Banks at this stage are so deleveraged and have so much excess reserves that there’s really very little risk.”
Martin Gilbert, CEO of £193 billion ($314 billion) Aberdeen Asset Management, sees the industry’s recent spurt of inflows into equities continuing as investors search for yield. “There’s nowhere else to put your money except equities,” he says. “If you had ignored the macro and focused on companies, you would have put your money to work a year ago.”
Aberdeen’s biggest challenge has been handling flows into emerging-markets equity funds. The company is considering taking steps to stem the flow of funds into EM equities — currently running at a rate of about £4 billion a year — because it feels that’s more than the firm can invest properly, Gilbert said.
Notwithstanding that caveat, Gilbert has reason to cheer the trend to equities. It’s good for business. Investors have been pulling money out of fixed-income products where Aberdeen’s margins can be as little as 15 basis points and going into equity funds where margins are 60 to 70 basis points.
To be sure, some participants cautioned against an outbreak of ebullience. David Rubenstein, co-CEO and co-founder of private equity firm The Carlyle Group, said some of the Davos crowd were exaggerating the extent of improvement in the market outlook. “When you’ve been depressed for five years, anything looks better,” he quipped. But even he saw a relatively benign outlook for the U.S., with growth running at a steady pace of 2 to 2.5 percent.
For some, it is a qualified confidence. One recurring theme of the meeting was the risk of today’s uncharted monetary-policy territory: Does the Federal Reserve Bank have a real strategy for exiting QE? Can it do so without triggering a market reversal, or worse?
Guggenheim Partners’ Minerd has as many doubts as anyone. He considers today’s market strength the product of “a perverse monetary policy that only seems to be getting worse,” following the Fed’s recent escalation of bond purchases. He expects the Fed to halt QE around the end of this year, which could trigger a bond market rout comparable to that of 1994, taking yields on 10-year Treasuries up to 3.5 to 4 percent. That would jolt markets but wouldn’t derail the economic recovery, he says.
Longer term, Minerd sees real trouble whenever the Fed tries to reverse QE and drain liquidity from the markets. “The likelihood that you could unwind the excess amount of high-powered money without having some sort of monetary or financial accident is extremely remote,” he says.
Of course, as John Maynard Keynes famously said, in the long run, we’re all dead. For now, Minerd — like many asset managers — is feeling pretty bullish.
