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Economic fears

As financial market pressures mount, Wall Street professionals are stockpiling cash, which now accounts for 4.7 percent of portfolios, up from 4.3 percent in October and the highest relative net allocation in 15 months, according to the October sentiment gauge. The shift to cash has occurred as a result of bond sales by investors.

Stock sentiment has shifted significantly bearish, with BofA’s Bull & Bear Indicator falling one-tenth of a point to 5.0, the gauge’s midpoint. The indicator compares cash levels to cyclical stocks to defensive stocks and equities to fixed income.

Investors are pessimistic about global growth, with net 6 percent expecting weaker conditions in the coming months, a 19-point drop from September and the lowest level since March 2020, when the pandemic began. Furthermore, earnings are expected to fall by a net 15% after the blistering 2021 pace.

Commodity allocations increased, while bond allocations fell to record lows as inflation fears grew.

Indeed, 48 percent of respondents named inflation as the most significant “tail risk” to the outlook, far ahead of China at 23 percent and far ahead of pandemic fears, which were mentioned by only 3 percent of the 430 panelists overseeing $1.3 trillion in assets under management.

The majority of respondents continue to believe that inflation is “transitory” – the Federal Reserve’s preferred term – rather than permanent, though the gap is closing. In October, transitory inflation led by 58 percent to 38 percent who believe inflation is here to stay. This is a decrease from 69 percent to 28 percent in September. Concerns about stagflation – higher inflation but lower economic growth – increased 14 percentage points to 34%.

In response to changing market conditions, fund managers shifted their bets in other ways as well.

They shifted from healthcare and consumer staples to banks and energy, which are now the world’s top two sectors. Energy stocks are now at their most oversold level since March 2012, owing to rising prices. For some companies that have resulted in an increase of target price, that has been the case for instance of the Tesla stock forecast.

Investors also reduced their exposure to utilities and staples, and Europe now has the largest allocation by country, despite the fact that U.S. overweight positions increased to a 12-month high.

In terms of interest rates, 44 percent of respondents expect the Fed to raise rates by 25 basis points in 2022, which is less than the two indicated by futures traders, according to the CME’s FedWatch tracker. There was a 24 percent split between those expecting two hikes and those expecting none.

Invest in the Chinese “slow economy” 

On Monday, China reported that its economy grew 4.9 percent year on year in the third quarter, falling short of the 5.2 percent expansion predicted by analysts in a Reuters poll. It comes after major banks slashed their 2021 economic growth forecasts for the world’s second-largest economy in recent months. This has helped to raise expectations towards large Chinese companies with a 25% increase of Alibaba stock forecast.

Analysts’ survey was conducted via email from September 28 to October 18. Respondents were asked how they plan to invest in China in light of the country’s economic challenges, as well as their investment horizon.

The strategists, who were all based in Asia or Europe, were given anonymity in exchange for their opinions.

Eleven of the 20 strategists polled said they were neutral or underweight in Chinese stocks and/or bonds. All mentioned regulatory tightening as a source of short-term uncertainty.

China, according to the remaining nine strategists, remains appealing. Six of them said they liked Chinese assets despite the weaker outlook, and three said they are long-term investors who can weather the current uncertainties.

Bears: Reduce China exposure

Six of the 11 who said they were neutral or underweight on China said they reduced their exposure this year.

One of them stated that he switched from overweight to underweight China in June or July, and that he reduced his exposure to both Chinese stocks and bonds.

Changes in government policies, according to the source, could result in better working conditions and higher data compliance costs, but they would also reduce companies’ pricing power and squeeze corporate margins.

“To become more optimistic, we would like to see evidence that the current regulatory cycle has bottomed, which it will,” he said. He went on to say that he avoided the real estate sector, preferred insurance over banks, and was picky about long-term opportunities in technology.

Another strategist, who downgraded his position to neutral in July, advised investors to avoid sectors targeted by regulators, such as real estate, health care, and the internet.

However, as stock prices fall, investors may look to invest in sectors with less policy uncertainty, such as green technology, consumer durables, and energy, he said. He added that Mainland markets appear “more appealing” than Chinese stocks listed abroad.

Bank of America has selected ten Asian stocks to buy this quarter.

Morningstar has identified two stocks that are “more sheltered” from China’s technological scrutiny.

UBS selects its top investment ideas for China, including ‘high quality’ real estate investments.

Some strategists polled saw better investment opportunities outside of China, particularly after mainland stock markets performed well in 2020.

“China was leading the rest of the global economy in the recovery from the COVID-19 crisis and has moved past the initial snapback surge phase, while other [developed] markets such as Europe and Japan had more room for growth to recover,” one strategist said.

Earlier this year, she downgraded Chinese stocks to neutral.

Bulls: There are more opportunities now.

Others stated that China continues to provide appealing investment opportunities.

One strategist stated that he became more optimistic about China in the fourth quarter. He explained that slowing economic growth could prompt Chinese policymakers to relax fiscal and monetary policies, as well as potentially slow regulatory tightening.

“Don’t forget that since COVID (and even before that), assets have been primarily driven by monetary and fiscal policy,” he said.

Another said the bond market was full of opportunities due to a “massive price dislocation,” particularly in the high-yield segment. Price dislocation occurs when financial markets are under stress and fail to price assets appropriately.

“There are more investment opportunities in China credit,” she said, “and we would start [to] deploy more cash now.”

Long-term positive

Regardless of their current exposure to China, nearly all of the strategists polled were more optimistic about investing in the Asian economic powerhouse in the medium- to long term.

According to one of the respondents, policy changes in China are generally aimed at improving business practices in various industries, and that better-run company can still deliver “decent” earnings growth despite regulatory changes.

According to three strategists, China will continue to be a major growth engine for the global economy for many years to come. As a result, they recommend that investors include some Chinese assets in their portfolios.

One of them stated that he sees consumer discretionary, health care, and information technology as long-term beneficiaries of government policies.

“When it comes to investing in China, we always take a long-term view because we see investing in China as a core strategy approach and investors should always have an allocation to China given its strong position in the global economy,” he said.

Tom Lee raises S&P 500 target

Lee, who has gained a following for calling the market bottom in March 2020 and remaining bullish as stocks have risen to new highs over the past year, raised his S&P 500 year-end price target to 4,800 from 4,700, and a 10% increase of Plug Power stock forecast on Tuesday night.

The new target is more than 6% higher than the market’s close on Tuesday (4,519.63), putting this rally on par with other rebounds from earlier in the year.

“The S&P 500 is up 20% year to date, but it has been a jerky year of progress.” We’ve already mentioned a slew of setbacks/headwinds, but the chart below depicts the type of ‘ping-pong’ market expected in 2021. “The S&P 500 rallied +7 percent after each of the two previous episodes,” Lee wrote in a client note.

Lee cited strong seasonal trends in the fourth quarter and declining Covid-19 cases in the United States as reasons for optimism. According to him, the recent bitcoin rally could be a sign of a broader risk-on movement.

The market has already begun to recover from a difficult September when the S&P 500 fell nearly 5%. Lee attributed the drop to concerns about stagflation and investors believing the market had reached a bottom, but he believes the bull case is on firmer ground.

“This pessimistic viewpoint may turn out to be correct. However, the improvement in market technicals, such as breaking through the 50-day moving average, suggests that underlying trends are strengthening,” according to the note.

Through Tuesday’s close, the S&P 500 was 0.6 percent off its high.