The state of suspended animation in today’s markets is remarkably bullish. U.S. growth forecasts are rising, S&P 500 earnings growth estimates for next year are running at a punchy 14%, corporate deal-making is picking up, and world stocks are at record highs.
The uncertainty immediately following President Donald Trump’s April 2 “Liberation Day” tariffs seems a distant memory. The relief rally has ripped for nearly three months, only taking a brief pause during the 12-day war between Israel and Iran.
It’s a pretty rosy outlook, some might say too rosy. If we do see a pullback, what will be the biggest “pain trades”?
The major pressure points are, unsurprisingly, in asset classes and markets where positioning and sentiment are most overloaded in one direction. As always with crowded trades, a sudden price reversal can push too many investors to the exit door at once, meaning not all will get out in time.
To identify the most overloaded positions, it’s useful to look at the Bank of America’s monthly global fund manager survey. In the June survey, the top three most-crowded trades right now are long gold (according to 41% of those polled), long “Magnificent Seven” tech stocks (23%), and short U.S. dollar (20%). This popularity, of course, means these three trades have been highly profitable. The “Mag 7” basket of Nvidia, Microsoft, Meta, Apple, Amazon, Alphabet and Tesla shares accounted for well over half of the S&P 500’s 58% two-year return in 2023 and 2024. The Roundhill equal-weighted “Mag 7” ETF is up 40% this year, and the Nasdaq 100 index, in which these seven stocks’ make up more than half of the market cap, this week hit a record high.
Meanwhile, the gold price has virtually doubled in the last two-and-a-half years, smashing its way to a record high $3,500 an ounce in April. And the dollar is down 10% this year, on track for its worst first half of any year since the era of free-floating exchange rates was established more than 50 years ago.
SLASH AND … BURN?
In some ways, these three trades are an offshoot of one fundamental bet: the deep-rooted view that the Federal Reserve will cut U.S. interest rates quite substantially in the next 18 months, a scenario that would make all these positions money-spinners.
Even though the Fed’s revised economic projections last week were notable for their hawkish tilt, rates futures markets have been upping their bets on lower rates, largely due to dovish comments from several Fed officials and a sharp fall in oil prices. Traders are now predicting 125 basis points of rate cuts by the end of next year.
Economists at Morgan Stanley are even more dovish, forecasting no change this year but 175 basis points of cuts next year. That would take the Fed funds range down to 2.5%-2.75%.
Lower borrowing costs would be especially positive for shares in companies that can expect high future growth rates, like Big Tech. Low rates are also, in theory, good for gold, a non-interest-bearing asset.
But, on the flip side, it’s difficult to construct a scenario in which the economy is chugging along, supporting equity performance, while the Fed is also slashing rates by 175 bps.
Easing on that scale and at that speed would almost certainly signal that the Fed was trying to put out a raging economic fire, most likely a severe slowdown or recession. While risk assets may not necessarily collapse in that environment, over-extended positions would be exposed.
Granted, this isn’t the first time investors have banked on Fed cuts in the past three years, and we have yet to see a major blow-up as a result. Markets have handled “higher-for-longer” rates much better than many observers warned, soaring to new highs in the process.
Still, if “pain trades” do emerge in the second half of the year, it will likely be because of one sore spot: a hawkish Fed.
(The opinions expressed here are those of the author, a columnist for Reuters.)
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