Please Stop Saying Everyone Is so Bearish

There is a broadly held notion that investors remain bearish with respect to equities. However, investor sentiment has become decidedly more bullish as is typical in late-cycle environments. Consider the following:

1. It remains difficult to say that investors are “euphoric” with respect to public equity, but their euphoria becomes quite evident if one included private equity and venture capital. Investors continue to pour assets into those “hot” asset classes while ignoring the opportunities in other equity classes.

2. Consensus has swiftly shifted in favor of cyclical stocks, yet implied probabilities continue to show that investors believe there is no chance of the Fed raising rates all the way out to January 2021.

3. Despite the popular notion that flows are pouring into fixedincome assets, equity ETF flows year-to-date appear to be gaining ground versus fixed-income ETF flows.

4. Investors’ rather perplexing sudden recognition that the US stock market has “new highs” is fueling momentum strategies. Investors might not be ebullient, but their behavior is increasingly typical of late cycles. Testing the fire extinguisher?

Lured by past outperformance: Venture vs. Emerging Markets

In several earlier reports, we highlighted that Empirical Research Partners’ analysis showed nominal flows to venture capital and private equity funds have now eclipsed the flows into US equities during the late-1990s Technology Bubble. There is also roughly $2 trillion dollars of “dry powder” (i.e., capital committed by investors but not yet called by managers) waiting to be invested globally in venture capital and private equity.

One basic rule of investing is that return on investment is highest when capital is scarce. These recent data suggest that private markets are not starved for capital. Rather, these asset classes seem historically flush with capital.

Investors are clearly chasing returns as they do toward most cycles’ end. Charts 1 and 2 show this emotional buying is quite typical. The first chart shows compounded returns for the Thomson Reuters Venture Index and for the MSCI Emerging Market Index from 2000 to 2009. 2000 (the start point in the chart) was the end of the Technology Bubble, but consensus remained that technology-related investments were a critical part of any growth portfolio. Emerging Markets were at the other end of investors’ emotional scale because EM had suffered a series of financial catastrophes and were accordingly unpopular. However, Emerging Markets outperformed Venture during the following decade by nearly 1,400 basis points per year.