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Stocks are riding high, so why are investment pros turning bearish?

Investors concerned about U.S.-China trade war
  • Although U.S. equities are clawing their way back toward record highs, some investment advisers worry that trade disputes and slowing economic growth could end the party. 
  • Michael Hartnett, chief investment strategist with Bank of America Merrill Lynch, said in a report that investors "have not been this bearish" since the 2008 financial crisis.
  • JPMorgan analysts forecast a 45% chance of the U.S. entering a recession in the next year, up from 20% at the start of 2018.

Stocks are again hovering around record highs, but that doesn't mean investors are breaking out the champagne.

"Are we whistling past the grave yard? To a certain extent we always do," said Art Hogan, chief market strategist at National Securities Corp. Market euphoria also was widespread in 1999, 2000 and 2007, and then "things didn't go so well after that," he recalled.

In fact, Wall Street hasn't felt this bleak in a good decade, according to a new Bank of America Merrill Lynch survey of money managers, which cited worries about the U.S.-China trade war, growing recession risks and monetary policy as the main factors driving the bearish sentiment. 

The June poll of fund managers, who oversee a combined $528 billion, found a growing number of investors piling into cash and fleeing equities. The spike in cash holdings — the biggest move into cash since a 2011 crisis over the U.S. debt ceiling — coincided with other defensive plays. Investors are also opting for bonds, utilities and consumer staples and pulling back from banking and technology stocks.

Investors "have not been this bearish since the global financial crisis, with pessimism driven by trade war and recession concerns," said Michael Hartnett, chief investment strategist with Bank of America Merrill Lynch, in a note.

The 'R' word

Although U.S. economic growth has been solid in recent quarters, concerns are starting to percolate. JPMorgan analysts now forecast a 45% chance of recession in the next year, up from 20% at the start of 2018.

President Donald Trump has repeatedly called on the Federal Reserve to cut interest rates to support economic growth. But there's no guarantee a rate cut is in the cards, with the central bank weighing troublesome economic data on manufacturing against pockets of strength, like the low rate of U.S. unemployment and lofty consumer spending. 

Concerns about the Trump administration's trade fights with China, the European Union and other countries are weighing on capital markets — as a result, businesses are pulling back on investment, one economist relayed. "If you can't decide what to do and when to do it, you end up doing nothing. If there isn't capital being put in place anywhere, the economy will slow," Dennis Hoffman, an economics professor at Arizona State University, said. 

That uncertainty over U.S. trade policy is unlikely to abate in the months ahead, especially as the 2020 presidential contest kicks into full gear, Hoffman said.  "There's hesitation today over fears of the trade wars and hesitation tomorrow as people consume copious amounts of media over the election," he added. "That's a recipe for a slowdown."

Fed to the rescue?

After jetting out to 3.1% growth in the first three months of the year, the economy has cooled, private forecasts show. Still, the expansion is on track to be the nation's longest on record in July.

Hit after Mr. Trump escalated his trade fight early last month, stocks have bounced back in recent weeks, buoyed in part by thinking that the Fed will cut interest rates. On Tuesday, equities climbed after the president tweeted that he would meet with Chinese President Xi Jinping at next week's Group of 20 summit in Japan.

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"The market believes that President Trump won't come to an agreement with President Xi at the G20 meeting in Osaka, Japan, at the end of this month, but does believe that the Fed will come to the rescue," Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, wrote in a note.

While the stock market is holding up well, Zaccarelli cautioned that the benefits of a rate cut could give way to doubt about future economic growth, and that could lead to steep declines.

Hopes for a trade truce

"The new news is the Fed might be more dovish than we thought, and we think Trump and Xi will met at the G20 and resume negations," said National Securities' Hogan of Tuesday's market rally, which had the S&P 500 rising to within 1% of its all-time high.

Despite the latest leg up by equities, the reality is that they are trading at the same levels as in August 2018, noted Hogan. Since the start of 2019, the market has mostly recovered from its end-of-year trouncing, when stocks fell 16% in the worst December in 80 years, he noted.

Consumers could face higher prices under new China tariffs

"In the last six months, equities have been great, but that's simply because we've recovered most of what we lost when we fell into that deep hole in December," said Hoffman. "It's challenging to measure the strength of the economy based on equity movements."