Stocks are doing something not seen since the tech bubble - and it could have devastating consequences for investors
- As the nine-year equity bull market continues, more and more signals are flashing that investor confidence is getting overextended.
- Morgan Stanley has found one metric that's the most stretched since the tech bubble, and it could be foreshadowing tough times ahead for stocks.
When an asset starts soaring, it's a natural instinct for an investor to want to buy it, even if they've already missed out on the initial leg up. The person figures the trend will continue, and that there's still ample money to be made.
This is the thought process behind a technique known as momentum investing, which involves the purchase of proven winners amid expectations of further gains. In an upward-trending environment like the current nine-year bull market, it can be highly lucrative.
But Morgan Stanley has uncovered a statistic that suggests investor hubris may be getting overextended. The firm finds that 57% of stocks included in the momentum strategy are so-called growth stocks - otherwise known as companies expected to see profit expansion that beats the market. That's the highest since the peak of the tech bubble in fall 2000.
The chart below shows this dynamic in play. Roughly 44% of growth stocks have overlapped with momentum over time, reiterating just how historically stretched the 57% reading is right now.
So what's the big deal? To hear some experts tell it, investors should be worried about how this stat plays into the growing narrative that risk appetite has been stretched too far. After all, a momentum strategy is all fun and games when the market is on an upward ascent, but can be considerably less amusing when chaos strikes.
Michael Hartnett, the chief investment strategist at Bank of America Merrill Lynch, weighed in late last week. He argued that investors should be looking to pare holdings in red-hot tech stocks, which have been surging for some time now, making them prime candidates for inclusion to a momentum strategy.
Hartnett has repeatedly questioned the level of risk being assumed by investors over the past year as conditions have gotten stretched, and is now urging the broad de-risking of portfolios.
His thoughts were similar to those made recently by Jim Paulsen, the chief investment strategist at Leuthold Group, who has consumer confidence firmly in his sights as he assesses what to do next. While Paulsen unsurprisingly finds confidence to be very high right now, he warns of the negative effect a decline in sentiment will have on the market cycle.
If there's anything in Morgan Stanley's findings that should give market bulls confidence, it's that the firm's measure of growth stocks as a percentage of momentum hasn't always portended an immediate selloff. Prior peaks have occurred in November 2011, May 2014, and August 2015, and yet we're still firmly in the bull market.
In the end, the troubling piece of data outlined above is useful to consider when assessing the big picture, rather than a standalone driving force. At the very least, it's a stat to continue watching closely, for signs of more ominous events to come.