INVESTMENT FOCUS-Stocks may be running out of steam

Reuters

By Natsuko Waki

LONDON, Nov 15 (Reuters) - Global stocks may be running outof room to rally further after a bumper year as the fragileeconomic recovery and the prospect of a cut in the FederalReserve's bond buying discourage big investors.

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

This year's rally is unique because it has been mainlydriven by mutual funds and retail investors. They have been ableto sustain inflows by reinvesting their income, as cash-richcorporates not confident enough to expand their businessesincrease dividends and buy back shares to reward shareholders.

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

Fund managers surveyed by Bank of America Merrill Lynch hada relatively high 4.6 percent of their portfolios in cash thismonth, while the number of investors saying equities areexpensive hit its highest level since January 2002.

Data from JP Morgan shows pension funds and insurers in theUnited 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 besensitive to all the tapering questions concerning the Fed,"said Benjamin Melman, head of asset allocation at Edmond deRothschild Asset Management in Paris.

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

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

The same measure for STOXX Europe 600, at 13.3percent, is at a four-year peak and notably above its average Of12.0.

So far this year, global equity funds have drawn $229billion of inflows or 3.7 percent of total assets undermanagement (AUM), with Europe attracting inflows for 20consecutive weeks, according to BofA data to November 13.

Bonds drew just $15 billion, or 0.5 percent of AUM, whilemoney market funds had $95 billion of outflows, equivalent to2.9 percent of AUM.

Respondents to the BofA survey said G7 bank lending growthand Chinese and Asian growth are the missing catalysts forfurther gains.

"Investors want to be involved in stocks but they are notfully invested," BofA's European investment strategist ManishKabra 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 andcutting back on loans.

There is also a long-term incentive for institutionalinvestors to avoid equities because of regulatory changes thatrequire funds to take on extra capital when they increaseholdings of risk assets.

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

TAPERING THREAT

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

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

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

Societe Generale says U.S. stocks will come under pressureif the equity risk premium - the excess return that investorsrequire to hold stocks over risk-free bonds - normalises to itslong-term average of 3.9 percent from the current 4.6 percentand bond yields to rise to 3.9 percent by end-2014.

"Rising bond yields during period of economic recovery arenot necessarily bad for equities," SG said in a note to clients.

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

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