The recent Dow Jones Industrial Average one-day plummet of 900 points didn’t stick, but the Nasdaq reversal on Tuesday led the market lower, and the Dow and S&P 500’s first down day in six, came uncomfortably right ahead of big tech earnings.
A recent survey of stock traders with $1 million or more in a brokerage account shows one reason why the bull market quickly resumed and why any single-day decline in stocks, tech or otherwise, may not stop the current bull market run from continuing. Wealthy, veteran investors were a little more bullish coming into third quarter earnings than they were just one quarter ago, and remain convinced in the strength of the U.S. economy and the opportunity to chase profits in the tech sector.
Millionaires describing themselves as bullish rose by 7 percentage points quarter over quarter, from 58% to 65% of investors, according to a survey of self-directed investors from Morgan Stanley’s E-Trade Financial. The largest group of millionaires expect gains to be modest, with a little less than half (46%) forecasting a 5% maximum gain. But very few foresee the big drop that bears have feared: only 6% of survey respondents said the markets will fall by 10% or more this quarter.
Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., July 13, 2021.
Brendan McDermid | Reuters
“They are still optimistic that the bull run will continue, but a bit more realistic in expectations, cognizant of where we are and just how far equities markets have rebounded,” said Mike Loewengart, managing director, investment strategy at E-Trade.
The E-Trade survey was conducted July 1 to July 9 among 898 self-directed active investors, with results from 157 investors with $1 million or more of investable assets broken out exclusively for CNBC.
Economic growth may still disappoint
The wealthy have an improved outlook on the U.S. economy even as inflation fears persist. The percentage of millionaires who graded the economy an A or B grade this quarter was up 13 percentage points since Q2, rising from a minority 39% last quarter to 52% at the start of Q3. Those who seemed unsure in Q2 (the 44% who graded the economy at a C) have moved into the more bullish camp, with that view falling to 29% of millionaires this quarter. Forty-one percent of millionaires described the current economic period as “expansionary” which was up from 30% who held that view last quarter.
“Optimism has the psychological momentum,” said Lew Altfest, CEO of Altfest Personal Wealth Management. But he added that the virus still has the potential to reverse that, evidenced by the Dow’s 900-point drop as the delta variant came into focus — the CDC is now revising its masking guidance again to be more cautious indoors — though he thinks the bigger risk to investor sentiment is that growth is just not as good as current expectations. “The optimism I have shared for a longer period of above-average growth is what we can still have, but the logical situation is sometime next year, less than a year from now, we will be looking at normalized growth and that isn’t what people want to hear.”
It is the reason that the bond markets have not reacted to Fed discussion of inflation and raising rates by pushing yields higher; in fact, fears of less than stellar economic growth have sent yields down in recent weeks.
Altfest said investors want to believe in the rosy outlook, and the year-over-year comparisons are large given the sudden recession caused by Covid-19, but if economic growth moderates to 2% to 2.5%, “that could be a psychological sobriety” event for investors, especially in light of high U.S. stock market valuations.
“There was a lot of gasoline thrown on the fire from the monetary and fiscal perspective,” Loewengart said, and some of it pre-dated the pandemic in the form of the Trump tax cuts and “even that was not moving growth in a big way,” he said. “It is important to keep that in mind. Growth remains elusive. We’re starting from a low base out of the pandemic and highly accommodative policy, but still it’s going to be challenging.”
Tech’s appeal is its earnings consistency
After even the biggest tech names proved vulnerable to temporary selling action in the second quarter, the wealthy rate tech as the third quarter’s best bet. Millionaires who say the tech sector is the best opportunity for gains in Q3 increased by 12 percentage points, an increase that came amid lower bond yields and tech’s continued strength, acting almost like a proxy for bonds, according to E-Trade.
Forty-six percent of the wealthy investors surveyed by E-Trade picked tech as their top target for gains this quarter, up from 34% in Q2.
“Tech’s great appeal in large-cap is delivering earnings rain or shine,” Altfest said. “I think tech has always been cyclical in people’s minds and for good reason, because people have always gotten hit from high price-to-earnings ratios. But this cycle, from 2008 on, it’s not like we just had an IBM … now we’re seeing many growth companies and less competition.”
Antitrust scrutiny will remain high and concerns about the power of trillion-dollar technology companies are an issue where many Democrats and Republicans agree. “Somewhere in here these companies are gonna have a cloud over them, but not so much a cloud that people wont be interested,” Altfest said.
“We’ve seen millionaires go back to old favorites,” Loewengart said. “We saw value outperform for a while, but when I see stronger performance of tech later on in Q2, the velocity with which tech bounced back, it drew investors in. … These are the ones that work,” he said. “Look at Apple saying it is increasing production of iPhones. It is tough to ignore from a business fundamentals perspective, to our daily lives.”
While tech ranked No. 1 among these wealthy investors in terms of sector appeal and rebounded sharply from last quarter’s view, it fell short of a majority view, at 46%. And interest remains among investors for energy which has been a strong value sector year to date.
Energy saw the second-largest increase in interest after tech, rising by six percentage points among millionaires choosing it as their top target, from 23% last quarter to 29% in Q3. Meanwhile, the reopening trade is one millionaires are easing off, with consumer discretionary declining as a focus of this group of investors from 31% last quarter ranking it No. 1 among sectors to 19% this quarter.
“They are taking a more balanced view of where they are seeing opportunities,” Loewengart said.
Millionaires are much less likely to believe the market is in a bubble, according to the survey, with respondents describing bubble conditions falling by 11 percentage points quarter over quarter, and notably lower (14% lower) than the broader investor population surveyed by E-Trade.
People are less worried about valuations, and the loudest bears like Jeremy Grantham have been proven wrong, at least for now, but that does not mean the recent belief in a new “Roaring 20s” plays out, according to Altfest. “I myself am feeling less enthusiastic about it, but still think it can happen. But if it doesn’t happen, we will be looking back at high P/Es and saying, ‘How could you think of this when you could see it was a temporary surge?'”
The equity markets took what Loewengart described as a breather in the second quarter, though early in Q2 it did seem like some investors were expecting the bubble to burst. “We’ve seen how resilient the markets can be. And that is what’s driving this sentiment,” he said.
Bubble concerns do remain a majority view. Fifty-six percent of the wealthy said the market is in a bubble or somewhat in a bubble, but that compares to 70% of all investors who hold that view, showing the wealthy to be more confident in market durability.
The inflation concern is real, and it was the top-cited risk to portfolios by wealthy investors in the survey, with 32% of millionaires saying it was their biggest fear. However, that is not leading to a major shift in the way the wealthy are positioning their money in the market.
“There are decidedly less millionaires that the general population making moves based on inflation,” Loewengart said. “That’s what struck me. It goes along with the view that the economy is recovering and stands to reason that higher rates will eventually accompany this growth.”
A minority (30%) of wealthy investors said they are selecting stocks based on rate sensitivity, and smaller percentages said inflation was leading them to move money to real estate investment trusts (19%), cash (18%),Treasury inflation-protected securities (16%), or commodities (15%).
“No doubt inflation is a topic of concern, and in general they see the market is not immune to all the short-term concerns going on, but we see them taking a long-term view of investments,” Loewengart said. “Investors are generally aligned with Powell and trusting the Fed assessment. We know that they are committed to equities overall, and equities are naturally well-suited to inflation over time.”
Altfest thinks the dramatic temporary increases will come down, but longer-term inflation will rise, just “not as absurdly high as it is now.”
The bond market is signaling it is not worried about inflation because it does not see major economic growth ahead, and there are warning signs that a downturn in economic expectations could hit stocks, but Altfest says the signs remain mild for now, more so than in the second quarter. A three-percent yield on the 10-year Treasury is still far off and that makes stocks inexpensive relative to history.
“We’re still far away from that, but at 3% rates, that is when the bonds really represent to more people real competition to stocks,” Altfest said. “At that point, the party for P/E will be over and investors will have to be focusing on the economy and if corporate profits are growing at a reasonable rate.”
In this period where optimism remains high and there is a back to “favorites” view from more of the wealthy stock market investors, some recent stock fads and momentum trades are seeing declining interest. While never a majority pick from the millionaires surveyed by E-Trade in recent quarters, respondents indicated some of the recent hot areas of the market are less appealing.
Interest in clean energy stocks dipped quarter over quarter from 46% of these investors to 35%; interest in IPOs declined from 30% to 23%; interest in SPACs declined from 26% to 19%; interest in crypto declined from 27% to 19%.
“What happened with meme stocks is extraordinary, but millionaires are cognizant of what extraordinary means,” Loewengart said.