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Stepan Lavrouk
Stepan Lavrouk
Articles (575) 

Morgan Stanley: Should Investors Factor in the Market's Fear of Missing Out?

It's not a good sign when everyone is too busy watching each other to bother checking the fundamentals

April 03, 2019 | About:

The market has been grinding steadily higher over the last week, leading many investors to believe they are missing out on the action. But is this move driven by actual fundamental strength, or something else? Is it the simple fear of missing out that is driving indexes higher? If the answer is the latter, then this move cannot be sustained for long. A recent research note from Morgan Stanley (NYSE:MS) explores this idea in further detail.

Trouble below the surface

Most of the major indexes are attempting to make new highs. The Dow Jones Industrial Average is near all-time highs, as are the S&P 500 and the Nasdaq. There are signs, however, that this latest bull run has become increasingly untethered from economic fundamentals, including the inability of the indexes to break those historical levels:

“Below the surface, there are some indications that perhaps earnings and economic growth in the U.S. are set to disappoint. Specifically, indices like the Dow Jones Industrial Average, the Dow Transports, KRE Regional Bank ETF and Russell 2000, which tracks small-cap stocks, all failed to make new highs in March. In the case of the KRE ETF, it is trading at almost 11% below its February 27 highs, and well below its 200-day moving average. We think such price action is consistent with the recent decline in Treasury yields and the inversion of yield curve, the first since 2007. We think it’s also supportive of our view that first quarter earnings season is likely to disappoint.”

A bad earnings season will not be the same as last time

The investment bank expects the first-quarter earnings season to disappoint investors. While some may think the market has already baked in this probability, they are likely to be wrong. A commonly held view is that since stocks rallied during the fourth quarter of 2018, they will do so again in the first quarter of 2019. There are reasons to believe it will be different this time around:

“In January, stocks were much cheaper, and the Fed was in the process of pivoting on its monetary policy, which caught many investors offsides after they had reduced positions in December. At this point, stocks are not nearly as cheap, and the market is well aware of the market’s pivot to a more dovish stance. Therefore, we are not so sure that stocks will rally this time.. I can’t remember a time in my career when institutional investors have been so preoccupied with what everyone else is doing. Almost every interaction I have today either starts or finishes with questions about how others are positioned, and who still has to buy. To say that FOMO, or the fear of missing out, is alive and well, would be a gross understatement.”

The end of a trend

If everyone is busy watching each other, no one is watching the fundamentals. This worrying state of affairs is confirmed by a number of other factors, such as the underperformance of cyclical stocks and small caps:

“In my experience, when investors are more focused on what everyone else is doing, rather than what the fundamentals are doing, it’s probably the end of a trend. For the record, this same anxiety was also present in December on the downside. In that case, it wasn’t fear of missing out, just fear. Our advice is to be prepared for some disappointments over the next few months as economic and earnings data come in soft, like this morning’s [Monday, April 1] retail sales.

I don’t know whether stocks will sell off or continue to grind higher as investors continue to experience FOMO, however what I do know is that the risk/reward of ignoring such data has deteriorated, and the underperformance of cyclicals and small caps suggests that the market may not be as complacent as it appears. Such divergences between the major averages and the cyclical parts of the market are generally resolved with a broader market correction. Therefore, remain patient with new capital as we enter first-quarter earnings season, and try to avoid FOMO.”

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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