Are Stocks Running Out of Steam?

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Dow Continues To Hit Record Highs On Hopes For Yellen's Policies
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By Natsuko Waki

LONDON -- Global stocks may be running out of room to rally further after a bumper year as the fragile economic recovery and the prospect of a cut in the Federal Reserve's bond buying discourage big investors.

Equities are the best performing asset so far in 2013, with the benchmark MSCI world equity index rising 17 percent since January. Wall Street and some European indexes have been hitting record highs on a daily basis.

This year's rally is unique because it has been mainly driven by mutual funds and retail investors. They have been able to sustain inflows by reinvesting their income, as cash-rich corporates not confident enough to expand their businesses increase dividends and buy back shares to reward shareholders.

In contrast, institutional investors -- who collectively manage $56 trillion, or 70 percent of global investment assets -- have yet to fully embrace this year's "Great Rotation" move into equities out of bonds.

Fund managers surveyed by Bank of America Merrill Lynch (BAC) had a relatively high 4.6 percent of their portfolios in cash this month, while the number of investors saying equities are expensive hit its highest level since January 2002.

Data from JPMorgan (JPM) shows pension funds and insurers in the United States, Japan, Europe and Britain have actually bought $230 billion of bonds in the first half of this year and sold $20 billion of equities.

"Right now we're sitting in our overweight equity positions. We wouldn't buy more. In the short term the market will be sensitive to all the tapering questions concerning the Fed," said Benjamin Melman, head of asset allocation at Edmond de Rothschild Asset Management in Paris.

"If you look at valuations, there's a far less room for maneuver compared with what we had previously. We probably won't see the same kind of performance on equities next year."

The ratio of equity prices to expected earnings over the next 12 months for the S&P 500 index is currently 14.8 -- the highest since 2010 and above its long-term average of 13.9.

The same measure for Stoxx Europe 600, at 13.3 percent, is at a four-year peak and notably above its average Of 12.0. %VIRTUAL-article-sponsoredlinks%So far this year, global equity funds have drawn $229 billion of inflows or 3.7 percent of total assets under management, with Europe attracting inflows for 20 consecutive weeks, according to Bank of America data to Nov. 13.

Bonds drew just $15 billion, or 0.5 percent of assets under management, while money market funds had $95 billion of outflows, equivalent to 2.9 percent of assets under management.

Respondents to the Bank of America survey said G7 bank lending growth and Chinese and Asian growth are the missing catalysts for further gains.

"Investors want to be involved in stocks but they are not fully invested," Bank of America's European investment strategist Manish Kabra said. "What will turn reluctant bulls into raging bulls? We need to see more bank lending growth in the G7."

Bank lending in the United States and Japan is accelerating, but European banks are still shrinking their balance sheets and cutting back on loans.

There is also a long-term incentive for institutional investors to avoid equities because of regulatory changes that require funds to take on extra capital when they increase holdings of risk assets.

"There's more regulatory burden to hold equities for institutions," Rothschild's Melman said.

Tapering Threat

Renewed discussion about when the Fed will start to scale back its monetary stimulus could prompt selling of equities as it would lead to higher U.S. Treasury yields.

Comments this week by next Fed chief Janet Yellen making plain she would keep the U.S. central bank's easy monetary policy until a job-creating economic recovery was in place have pushed stocks back towards five-year highs.

A string of U.S. data pointing to a stronger recovery had recently prompted markets to revise their expectations of when the Fed will begin to taper to early as December from March.

Societe Generale says U.S. stocks will come under pressure if the equity risk premium -- the excess return that investors require to hold stocks over risk-free bonds -- normalizes to its long-term average of 3.9 percent from the current 4.6 percent and bond yields to rise to 3.9 percent by end-2014.

"Rising bond yields during period of economic recovery are not necessarily bad for equities," SG said in a note to clients.

"However, at a time when earnings momentum remains weak and the consensus earnings growth estimate is expected to moderate, rising bond yields could be a catalyst for a U.S. equity market correction."

12 PHOTOS
Forbes' World’s Most Powerful People List, 2013 Edition
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Are Stocks Running Out of Steam?

Who’s more powerful: the omnipotent head of a corroding but still feisty power or the handcuffed head of the most dominant country in the world? This year’s snapshot of power puts the Russian president on top. Putin has solidified his control over Russia (“dictator” is no longer an outlandish word to ponder) and the global stage. Anyone watching the chess match over Syria has a clear idea of the shift in the power towards Putin. The ex-KGB strongman -- who controls a nuclear-tipped army, a permanent seat on the UN Security Council and some of the world's largest oil and gas reserves -- is allowed to serve two more terms, which could keep him office until 2024.

His signature legislation, Obamacare, is under fire, U.S. allies are outraged over NSA surveillance overseas, and the government shutdown for 16 days in October begs the question: Who's in control here? It appears that President Obama's lame duck period has set in earlier than usual for a two-term president, causing him to drop one notch from the No. 1 spot. To be sure, though, the leader of the free world remains in charge of the most powerful nation in the world, with the largest, most innovative economy and the deadliest military. 

Recently promoted in March, the 60-year-old is the paramount political and military leader of China. Xi exercises near dictatorial control over 1.3 billion people (close to 20% of the world's population). China has the world's largest central bank, with $3.5 trillion in assets -- and owns some $1.3 trillion in U.S. securities, making it the largest foreign shareholder of U.S. debt. Along with India, the country is predicted to overtake the U.S. in aggregate GDP in coming decades; it is currently $8.2 trillion. There are 122 billionaires in the country, up from zero one decade ago. In addition to his title of general secretary of the Communist Party in China, Xi is also president of the People's Republic of China and the chairman of the Central Military Commission.

The March election of Pope Francis has injected new energy into the world’s largest religion, with 1.2 billion followers around the world. The first Jesuit and Latin American Vicar of Christ preaches compassion for the poor and a greater role for women while signaling for the church to quiet its focus on “only on issues related to abortion, gay marriage and the use of contraceptives." He has embraced social media, regularly using Twitter to dispense religious advice to his 10 million followers and is responsible for the world's first papal "selfie." Born in Buenos Aires as one of five children of an Italian immigrant railway worker, Pope Francis (né Jorge Mario Bergoglio) is an avid FIFA fan and cheers the San Lorenzo de Almagro club.

The world's most powerful woman is the backbone of the 27-member European Union and carries the fate of the euro on her shoulders as Germany's chancellor. Merkel's hard-line austerity prescription for easing the European debt crisis has been challenged by both hard-hit southern countries and the more affluent north, most particularly French President Francois Hollande. Merkel is fresh off a commanding reelection victory, and has served as ­chancellor since 2005; the first woman in the position. Merkel has earned the top spot on the FORBES list of Most Powerful Women In The World for eight of the past 10 years.

Gates is the wealthiest man in the U.S., despite his past gifts of more than $28 billion to the Bill & Melinda Gates Foundation. He bolstered his foundation's efforts to eradicate polio in April, securing $335 million in pledges to the cause from six billionaire comrades, including $100 million each from Mexico's Carlos Slim and New York City Mayor Mike Bloomberg. Shares of Microsoft jumped in late August on news that Steve Ballmer will step down as CEO; Gates will remain chairman of the software company he cofounded with Paul Allen in 1975. He and fellow Most Powerful Warren Buffett have thus far convinced over 100 billionaires to sign on to the Giving Pledge, a promise to donate at least half one's net worth to charity.

Big Ben is stepping down as of Jan. 31, 2014, and Janet Yellen has been nominated to lead the Fed next year. Bernanke has served as chairman during some of the biggest financial challenges since the Depression. The former Princeton professor’s decisive actions and policies helped to avert a global economic meltdown during late 2000s fiscal crisis, and jump-started a still-moderate U.S. recovery. The American economy's "adult in the room" has said that there is only so much the Fed can do; politicians are the ones with the power to keep us from going over a fiscal cliff.

Saudi Arabia's aging monarch holds the keys to two of Islam's holiest mosques and the world's second largest crude oil deposit of 265 billion barrels, amounting to 20% of the world's reserves. The Kingdom boasts a $727 billion GDP, putting it among the top 20 richest countries worldwide. But with 12% of Saudi nationals without a job, including 25% of its under 25s, the king has pushed $130 billion at unemployment funds and housing projects in recent years.

As chief banker of the world's largest ­currency area -- the euro zone's collective GDP is now nearly $17 trillion -- Draghi faces the Herculean task of trying to maintain financial unity across 17 countries. But if anyone can wrangle the interests of nations as diverse as Germany and Greece, it might be the man who navigated the minefield of Italian politics so deftly that he earned himself the nickname "Super Mario."

Duke heads the world's No. 1 retailer ($470 billion in revenues in 2012) and biggest private employer (2.2 million employees). Wal-Mart can make or break a company simply by deciding to stock its products. Last year, Sweden's $785 billion-in-assets sovereign wealth fund (none bigger) dropped its Wal-Mart stock -- reportedly worth about $140 billion -- on advice from its Ethical Council that cited a "serious and systematic abuse of workers' rights."

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