Private investors more optimistic than ever, but institutional investors more pessimistic than ever. Is now the time to invest in bonds back?

Chart of the week

The chart shows market sentiment among individual investors (AAII, American Associtation of Individiual Investors) and large institutional investors (FMS, Fund Manager Survey, Overweight in Equities).

Why it matters

As the chart shows, normally the investment sentiment of individual investors and institutional investors is about the same. There are divergences, but they are usually small and resolve in a short period of time. Currently, this is not the case. The euphoria of private investors, which is mainly driven by the bubble in technology stocks with the theme of artificial intelligence, and on the other hand the caution of institutional investors has never been so great in the past 20 years.

The chart shows a survey of institutional investors on which asset class they think is overvalued and expect a correction soon.

The chart is very interesting for the following reason: the stock market rises when more investors buy than sell. Normally, investment money flows into an asset class in the following pattern. First hedge funds buy, then institutional investors, then banks for their clients, and then lastly retail investors. Often the last thing people talk about is a housewives' or cab drivers' rally. If you are asked by people who otherwise never have anything to do with the financial markets, which AI shares you should still buy now, then it is clear that the buying stream is coming to an end.

The chart shows how much investors in the NASDAQ technology exchange are currently using leveraged positions. These investors invest in futures with a tenfold leverage or with options. In all phases where the positioning with derivatives on a further stock market rise was so high, there was a correction soon afterwards.

The situation is further exacerbated when you look at the S&P 500. This is the most watched stock index in the USA. There, hedging with put options and futures has never been so high in recent years. In the index, institutional investors hedge against falling prices.
We would like to take this opportunity to once again clearly and explicitly warn against investing in shares with the theme of artificial intelligence. The technology certainly has a future, but anyone who gets in now will very likely get a bloody nose. Lucky investors who bet on the topic in time are advised to take profits now.

Is now the time to invest in bonds back?

Last week, the Federal Reserve stopped raising interest rates. In America, the unemployment rate has increased and the Purchasing Managers Index also indicates a slowdown.

The chart shows market participants' expectations of how the U.S. Federal Reserve will decide in the next 12 meetings. The highest probability is shown in blue.

Most investors still expect an interest rate hike of 0.25% in July, then interest rates should remain stable until the end of the year.

In Europe, the European Central Bank (ECB) raised interest rates last week and hinted at a further rate hike in July.
As the chart above shows, inflationary pressures should also ease in Europe. Producer prices (PPI), which normally have a 9 month lead time, are running sharply lower. It can therefore be assumed that interest rates will not be raised again soon in Europe either.

The chart shows a Bank of America survey of large institutional investors. They are starting to invest in bonds again. After being underweight in bonds for more than 10 years, many have now returned to overweighting bonds.

The chart shows how the yield curve has shifted upward. Compared with last year and March 2023, it is now at a higher, more realistic level. Further interest rate hikes are no longer underestimated, but rather overestimated. The timing of getting back into bonds now makes sense.

The chart shows when bonds and equities have moved in the same direction in the past and when bonds have been a good diversification. As bonds have been a good diversification in the majority of the last 20 years, the times when they were not are more numerous.

It turns out that bonds serve their purpose for diversification when inflation is low. It will likely be some time before that is the case.
We are on the verge of a recession in the economy. In such phases, spreads between corporate bonds and government bonds normally increase sharply. In addition, the yield curve is expected to normalize again soon.

So those who already want to invest in bonds again should focus on short-term government bonds and corporate bonds of very high quality of 1 to 2 years.