By Noel Randewich
(Reuters) - Record upside surprises in U.S. economic data are bolstering the case for a “V” shaped recovery from the COVID-19 recession and boosting investor confidence in a stock rally that has already delivered hefty gains in recent months.
Citigroup (NYSE:C)'s Economic Surprise Index <.CESIUSD>, which tracks economic data relative to economists' expectations, hit a record high this month, reflecting recent turnarounds in key areas such as unemployment that have helped extend the S&P 500's gain to 40% since late March. The stock index jumped 1.9% on Tuesday, helped by a record surge in May retail sales.
(GRAPHIC - Could it be a 'V'?: https://fingfx.thomsonreuters.com/gfx/mkt/xlbpggkrqpq/Pasted%20image%201592323348223.png)
The improving data, along with signals that the Federal Reserve remains ready to backstop the U.S. economy, have eased concerns that the stocks rally has ignored the economic devastation wrought by the pandemic and resulting lockdowns.
“The safety-net (Fed Chair Jerome) Powell has put in place is not going away any time soon,” said Edward Moya, senior market analyst at OANDA. “While we will see the economy struggle, you won’t likely see a sustained pullback in equities because of all the stimulus that has been thrown at the market.”
Many investors doubt the market's rebound can run much further. A recent surge of COVID-19 cases in some U.S. states and a new cluster of cases in China have raised concerns over a coronavirus resurgence, while subdued demand for commodities such as oil signal a potentially slow comeback in global growth.
Influential U.S. investors, including David Tepper and Stanley Druckenmiller, in May described markets as over-valued and with terrible risk-reward, with Druckenmiller dismissing V-recovery hopes as “a fantasy."
Still, the ranks of doubters have thinned lately, while bullish sentiment has grown. The percentage of fund managers who believe the bounce is a bear market rally that will eventually reverse fell to just over half in June, from more than two-thirds last month, a survey from BofA Global Research showed.
“Positive sentiment begets positive sentiment,” said Torsten Slok, chief economist at Deutsche Bank (DE:DBKGn) Securities. “People are starting to think that this is not a bear market rally, that this is more permanent.”
The market’s gains also appear to be attracting inflows of cash from the sidelines. Cash levels among fund managers in BofA's survey registered their biggest drop in more than a decade in June, and net equity exposure among hedge funds soared to 52% from 34% in May.
Investors poured a net $20.4 billion into equity-focused mutual funds in the week ending June 10, the largest one-week inflow since 2007, Lipper data showed.
(GRAPHIC - U.S. Domestic Stock Fund Flows: https://fingfx.thomsonreuters.com/gfx/mkt/nmovakendva/n6Jru-u-s-domestic-stock-fund-flows-nbsp-%20(1).png)
The rally has exacerbated some investor concerns, including those over stock valuations. The S&P 500's forward price/earnings ratio, a closely followed valuation metric, now stands at 22, a level that was last seen 20 years ago, during the dot-com boom.
For many investors, “it's still love/hate," said Joe Saluzzi, co-manager of trading at Themis Trading. "If you're a fund manager, you have to be in the market because you have to beat your benchmark, so a lot of managers have to get in there and performance chase."
(GRAPHIC - S&P 500 forward PE hits dot-com highs: https://fingfx.thomsonreuters.com/gfx/mkt/yzdvxdmojvx/Annotation%202020-06-16%20102318.jpg)
At the same time, gains in the prices of oil and some other commodities have slowed in recent weeks, raising concerns that weak demand for raw materials may indicate a lackluster worldwide recovery.
The Organization for Economic Cooperation and Development forecast the global economy could contract by 7.6% if the world sees a second wave of the coronavirus outbreak.
Still, there are signs that investors remain bullish despite the market's recent gains. The proportion of investors buying S&P 500 bullish call options versus bearish put options rose sharply last week, suggesting some traders are betting the market will continue rising.