Risk is back. Speculative stocks crushed during the recent bear market are all the rage again, staging huge rallies over the past five weeks.
- Speculative stocks have posted big gains since the start of the year after bruising losses in 2022.
- The AAII investor sentiment survey has just swung bullish, but remains far from prior peaks.
- The 10-year Treasury yield pulled back in January, boosting investors' risk appetite.
- The equity risk premium has dropped to the lowest point since 2008, implying poor forward returns for stocks.
Tesla (TSLA), the maker of electric vehicles and a current favorite with retail investors, has doubled in market value from its Jan. 6 intraday low.
The "apes" of meme stock fame are snapping up artificial intelligence plays with an enthusiasm they once showed for AMC (AMC), Gamestop (GME), and crypto, while still finding the time to bid up AMC and Gamestop 40% and 28% respectively in the past month.
Shares of online autos merchant Carvana (CVNA) have more than tripled in value since the start of the year. To be sure, they're still down 96% from their 2021 peak after losing 98% of their value last year. But this is about this year, not last year.
The enthusiasm has started to spread from Redditors and option players to Main Street. On Wednesday, bulls finally surged past bears in the weekly American Association of Individual Investors sentiment survey for the first time in 10 months.
The survey is a contrarian indicator: bears outnumbered bulls by 16 percentage points two months ago. But this week's surge in bullish sentiment and comparable decline in bearishness has only brought the gauge back to neutral territory, with bulls and fence-sitters tied at 37.5% and bears hardly giving up at 25%. The numbers suggest the market rally could attract plenty of latecomers absent bearish developments.
Equity markets are climbing a wall of worry featuring persistent recession and inflation fears, as well as recent speculation that the tight job market will force the Federal Reserve to lift its benchmark overnight interest rate to as high as 6%.
Risk appetite has returned with a vengeance despite the Fed hiking the federal funds rate from near zero to more than 4.5% over the last year. Retail trading as a share of total volume hit a record in the last week of January, surpassing the prior peak in early 2021, according to JPMorgan.
It's helped that the 10-year Treasury yield ended January near four-month lows. In recent years, risk appetite in the stock market has increased when the 10-year rate fell, and vice versa.
As it is, the equity risk premium, or the extra return investors demand to own stocks instead of U.S. government bonds, has dropped to longtime lows. By one reckoning, it was recently the lowest since 2008 and lower than 92% of readings since 2006. According to the same analysis, the lowest decile in equity risk premium values has been followed by an S&P 500 decline of 9% over the next 12 months, on average.
The apes don't care, though, and stodgier investors are starting to shed their reservations. Until that changes, the low equity risk premium can remain just another brick in that wall the stock market has been climbing.