As stocks and gold continue to climb in 2016, one of Wall Street's largest firms has a clear message for investors: There could be trouble brewing in this rally.
Prices on bullion and government debt, two of the safest of safe havens, have skyrocketed this year even as risk-sensitive assets have powered higheras well. According to some, that isn't a good thing.
"I believe we are seeing signs of froth in perceived safe assets," advised Stephen Parker, Head of Thematic Solutions for J.P. Morgan Private bank on CNBC's "Futures Now" last week.
Initially, Parker said, the optimism was warranted as fundamentals justified the risk rally. In particular, stronger-than-expected earnings, bolstered by top line revenue growth, have surprised to the upside, That "...is something we haven't seen in recent quarters," he said. Through Friday, 65 per cent of earnings reports have come in above estimates led by beats from General Electric and Whirlpool, which has encouraged investors.
"You're seeing better signs of stabilizing economic growth," said Parker. "Economic surprises in the US have reached their best levels since the beginning of 2015."
'Forced to chase' a rally
During the past 2 years, the Dow Jones Industrial Average and S&P 500 Index are up 8 and 10 per cent, respectively. Furthermore, US markets have continually weathered the fallout from bearish events like Brexit, volatile oil prices, terrorism and a global negative interest rate environment. "Investors have been caught a little bit offside in terms of being too cautiously positioned," Parker said. "Fund managers are sitting on the highest levels of cash they've had since 2001. Now that markets are rallying, they're being forced to chase." This is where Parker says the danger is for investors. "You need safe haven assets to manage volatility," Parker said in reference to owning US Treasuries. "But I think you need to be careful right now."
Investors appear to be heeding Parker's call, at least in the short term. US bonds sold off last week, pushing yields to a six-week high (bond yields move inversely to prices). Notably, the US 10-year yield rose above 1.60 per cent for the first time since the Friday following Brexit. In addition to bonds, Parker warned of the pitfalls that lie in sectors like utilities and consumer staples, as investors hunt for yield. Despite modest growth expectations, consumer staples trade at 22 times forward earnings and utilities, which historically trade at a 20 per cent discount to the market. They are currently trading at a premium.
Parker explained that, with low US interest rates, typical safe haven assets have gotten too expensive.
Notably, gold has been on a meteoric rise and is currently trading at levels not in nearly 2 years. From here, Parker said it may be time for investors to pivot away from expensive parts of the market, and get back into more cyclical sectors like consumer discretionary, technology and energy. He expects those assets to be supportive of US markets in the long-term.
Additionally, Parker urged investors to consider opportunities that exist in emerging markets now that global growth and commodities have stabilized. Meanwhile, the US dollar, another safe haven, has settled in a less volatile range.
"Lower rates and a patient Fed are good for emerging markets," Parker told CNBC.
"Despite outperforming this year, emerging markets have lagged US markets by over 70 per cent since the end of 2012 and valuations remain attractive," he said. "Investors who have thrown in the towel on emerging markets in recent years are beginning to take another look." In a research note to clients last week, Bank of America noted record flows into emerging market bonds, which jumped to nearly $5 billion this past week. That exceeded a record of $3.4 billion set just two weeks ago.
Year-to-date, EEM, the exchange traded fund made up of emerging markets equities in South Korea, China and Taiwan, is up 11 per cent.