Interest rates in America rising again, valuation of stocks, expectations of institutional investors.

Chart of the week

The Citigroup Economic Surprise Index is an economic indicator of Citigroup. It indicates whether actual economic development is in line with general forecasts.
If the index rises, the U.S. economy is performing better than analysts expected.
Why this is important
Currently, the index is rising sharply. The U.S. economy is performing much better than many expected. Some already believe that there will be no recession. Normally, this is good for the stock markets. When the economy is doing better, companies can earn more and stocks go up.

Currently, however, it is the other way around. If the economy does not cool down as expected, inflation will not go down either. The central bank is then forced to continue raising interest rates massively.

The chart shows which interest rate hike investors expect at the next decision of the U.S. Federal Reserve on March 22. We already showed the chart last week. Just two weeks ago, 0% expected a 50 basis point increase and the expectation rose to 9.2%. In the current week, the movement continued. Now it is already 20% who expect a 50 basis point rate hike.

This fear of further sharp increases in interest rates then also put pressure on the stock market.

Valuation of the shares

The chart shows the valuation of shares based on the price/earnings ratio. The average P/E in the technology sector is 22 (blue bar). This means that if someone were to buy a technology company outright today, the profit would have to be as high as it is today for 22 years before he financed his purchase price. Only from the 23 year he makes profit as an investor.

Although the stock markets have already fallen sharply, valuations in almost all sectors are roughly at the ten-year average (blue triangle). In the technology sector, valuations at the high of the last 10 years were around 30 (yellow rectangle) and have now come down to 22. However, at the low of the last 10 years, valuations were at a P/E of 10 (red rectangle).

The companies are currently fairly valued, but not yet cheap. The only exceptions seem to be the energy sector and the telecom sector.

The chart shows 16 sub-indicators and their average of sentiment indicators that the investment bank Goldman Sachs uses to assess the markets. The overall indicator (first line) has improved compared to last month (orange) and three months ago (blue).
If the indicator is on the left, in "risk-off" territory, investors are avoiding risk and selling. Often they do not reinvest, but simply increase the cash ratio in the portfolio. The situation is completely different on the right-hand side (risk-on). Here, investors forget the risks, get greedy and buy like crazy without looking at the valuation.

In the chart, the big change in the two indicators "AAII Bull vs. Bear" and "Risky Bond Flows (3m)" is particularly striking. Both track the sentiment of retail investors. The first conclusion from the chart is that the rally since the beginning of the year was mostly driven by private investors and not by the large institutional investors. They have only moved minimally.

The second thing that stands out is that almost all bond indicators (bond flows) are still in the "risk-off" range. So bond investors are much more pessimistic than equity investors. The question here is whether equity investors or bond investors have the better forecasting ability. Here, the historical conclusion is clear. Bond investors are usually right. This is because almost only large institutional investors are active in this area, and private investors, who are guided by short-term trends, are almost only active in equities.  

Expectations of institutional investors
We like to look at a Bank of America survey of the largest institutional investors each month. Since this group of investors is responsible for 80% to 90% of all volume in the markets, we can tell by their behavior which markets are overvalued and where opportunities are opening up.

The chart shows how many of the major institutional investors expect inflation to continue rising. In other words, the very fears that emerged last week. There are almost none. This is where the greatest danger currently lies. If inflation does not go down, as most expect, then all the major investors are wrongly positioned.

Here, institutional investors were asked whether their risk appetite had increased in recent weeks. This was the case. At a very low level, it has increased.

Here, institutional investors were asked whether they overweight equities or bonds. There has been little change here. So although investors would be willing to take on more risk, they have not (yet) changed their investment behavior in response. This strengthens the assumption that the rally since the beginning of the year has been driven only by retail investors.

The chart shows investors' expectations as to whether the current price development was a normal countermovement in a still falling trend (Bear market ralley) or whether we have already seen a trend reversal (New bull market). Here the conclusion is clear. Most institutional investors do not yet see a major trend reversal and remain cautiously invested.

Here, the major institutional investors were asked where they see the greatest risks. The risk that inflation will remain high is certainly the biggest threat to the economy at present. But concerns about geopolitical developments have also increased.

The chart shows in which areas institutional investors see an overvaluation, and therefore where no new investment money will flow. In particular, equities in China (after a rally of almost 30%) and corporate bonds are seen here. The mention of corporate bonds is somewhat surprising, as prices here had not yet recovered strongly after the collapse in 2022.

On the other hand, investors' view on the USD seems to be changing. After the USD lost almost 12% against the EUR, many no longer see the USD as overvalued.