Risks are growing of an unwind in the powerful fund flows that drove US stocks to record highs in recent weeks, according to Citadel Securities’ Scott Rubner.
The S&P 500 Index has surged about 16% from its March low, supported by robust earnings, corporate buybacks and heavy buying from retail investors. But while fundamentals remain strong, signs of froth are mounting and bond yields are on the rise, said Rubner, the firm’s head of equity and equity derivatives strategy, in a note to clients.
“The near-term setup now warrants more tactical caution,” Rubner wrote. “Many of the flows that helped drive the rally now appear significantly more mature. Higher long-end rates are beginning to create competition for equities again.”
The S&P 500 has risen for seven straight weeks, with investors largely shrugging off a war in the Middle East that has lifted oil prices above $100 per barrel, growing inflation worries and expectations that the Federal Reserve may need to raise interest rates.
Rubner pointed to several reasons for caution. While retail and institutional investors have piled into stocks, the market looks significantly more crowded than it did just six weeks ago, he wrote.
Yields on 30-year US Treasuries are hovering near the highest levels in almost three years, dulling the allure of stocks.
Additionally, the rally remains narrow, with a handful of megacap technology stocks accounting for most of the gains in the S&P 500: Just 27% of the benchmark’s constituents have outperformed the index over the past 30 trading days, according to Rubner.
Meanwhile, “the market now appears materially less protected against a short-term volatility event,” because investors are less hedged for the downside than they were several weeks ago, Rubner wrote.
“Passive inflows, buybacks, retail participation, and levered ETF exposure have all accelerated alongside the rally, but many of these same flows now leave the market increasingly vulnerable to a short-term unwind if momentum begins to stall,” Rubner said.
Written by: Michael Msika and Natalia Kniazhevich @Bloomberg
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