Investors have become ‘euphoric’ so a peak could be near, RBC says

Wall Street’s biggest money managers are the most upbeat on stocks than they’ve been in months, a sign investors should herald as an omen of a market top in the months ahead, according to investment bank RBC Capital.

“Positioning in the US equity market among institutional investors has turned euphoric and highlights the extent to which FOMO (fear of missing out) has gripped the institutional equity investor community,” RBC Head of U.S. Equity Strategy Lori Calvasina wrote to clients.

“This keeps us on guard for a period of significant consolidation near-term, and will be an overhang on 2020 performance if not resolved before year end,” the stock strategist added. “When we look at stock market valuations from the perspective of a stock picker, we also see signs of froth in the US equity market.”

Calvasina said her caution stems from data showing that asset managers have pushed exposure in U.S. equities through the futures market just above their positioning in July 2019, September 2018, January 2018 and 2007 highs. All of those dates marked “major” peaks in the American stock market.

Specifically, Commodity Futures Trading Commission data on U.S. equity futures positioning in November returned to highs in line with pre-Financial Crisis highs, according to RBC analysis. The indicator moved up again the fourth quarter after a summertime plunge, when it fell about halfway back down to the May and December 2018 lows.

_{Source: RBC US Equity Strategy}

Though both the Dow Jones Industrial Average and the S&P 500 were both on track to post gains of more than 20% in 2019, the recent all-time highs in U.S. equity markets follow a turbulent summer.

Markets began a months-long slump in late July as soured trade relations between the U.S. and China forced traders to recalibrate their expectations for a resolution between the globe’s two largest economies. The S&P 500 sank nearly 6% between July 26 and August 5, with large-cap equities trading in a range between 2,825 and 2,940 for the following month.

RBC isn’t the only investment bank with concerns about funneling more money into equities at current prices. The market’s recent has also left some worried that equities may be overpriced in general, with the plurality of strategists surveyed by CNBC advocating a stricter stock-picking strategy in the near term.

Investment advisors looking ahead to 2020 have stressed a portfolio that prioritizes low debt and consistent income. Nearly all strategists with 2020 outlooks highlighted the importance of finding under-loved stocks with solid fundamentals opposed to the high-premium, high-growth equities that fueled the S&P 500 for much of the past five years.

But marginal improvements in trade rhetoric — notably a “Phase One” trade truce with Beijing — and three interest rate cuts from the Federal Reserve through October rekindled investors’ appetite for stocks, which have rallied 10% since last month’s low.

But Calvasina isn’t convinced quite yet and argued that the market “has gotten a little too excited about the economy and the Fed.”

“The sharp year-over-year gain in the stock market for 4Q19 is something that would normally be seen when the US economy is rapidly accelerating — something that has not been manifest in recent economic data, and something that is not anticipated by sell-side economists (including RBC’s) in coming quarters,” the strategist wrote.

A report from the Commerce Department on Wednesday showed that GDP rose at a 2.1% annual pace in the third quarter, a rate which many economists feel could represent a sort-of growth ceiling for the U.S. over the next decade. But lingering hope among investors that the U.S. economy will be able to surprise to the upside may be what’s keeping the current rally alive, RBC warned.

“Realization by equity investors that the US is likely to see moderate as opposed to rapid economic growth in the year ahead could be a catalyst for profit taking,” she added.

Despite the call for a short-term pullback, Calvasina thinks the market will recover in 2020. She issued a 2020 S&P 500 target of 3,350, which is slightly higher than the median projection of the strategists tracked by CNBC and implies 6.6% upside from Tuesday’s close.