Despite economic improvements, some fear ‘black swan’ event

Amid encouraging economic news – falling inflation, stable stock market, positive jobs CPI, and GDP numbers – a significant number of institutional investors in the U.S. are nevertheless bracing themselves for what’s called a “black swan,” or “tail risk” event, according to the latest CoreData's Equities Sentiment Report. The study surveyed 100 U.S. institutional investors in June and found growing fears that recent upheavals in the banking sector may serve as a precursor to a more significant financial crisis.

The report said six out of ten investors believe there is a high probability of a tail risk event occurring within the next three months. Such an event is defined as a type of risk that is rare yet extreme. They have an extremely low possibility of taking place but if they do, they can have a huge impact. Similar to a black swan event, which is an unpredictable occurrence with extreme, paradigm-shifting repercussions. In stock market terms, a black swan event cannot be predicted using standard forecast models and only in retrospect can the negative market and investing impacts be seen as avoidable.

Bank failures cited

What’s got institutional investors spooked are the recent bank failures that have amplified concerns about the economy. Four in 10 (38%) investors think the Fed’s support for lenders has
shored up market confidence only temporarily and that a bigger financial crisis is coming. Fears about the repercussions of recent bank failures are feeding into a gloomy outlook for the economy amid expectations of persistent inflation and high rates.

About half (47%) of respondents think the impact of the regional banking crisis on lending conditions will put a brake on economic growth. And two thirds (65%) expect interest rates and inflation to remain elevated for the next year. In addition, 45% think US sovereign debt levels pose a major challenge for the economy in the medium term.

“Our Equities Sentiment Report shows the short-term outlook for the U.S. market is bearish as macro headwinds and fears over the impact of the recent bank crisis send jittery investors into risk-off mode,” said Andrew Inwood, founder and principal of CoreData. “While the outlook is sunnier over the next 12 months, expectations of elevated rates and stubborn inflation cast a cloud over investor confidence.”

Optimism around larger stocks

More than half of the respondents in CoreData’s report express a bearish sentiment towards U.S. equities in the short term. However, within the equities market, investors harbor expectations that larger stocks will outperform, with over 40% anticipating the highest returns from mega-cap companies.

While a slim majority of investors maintain a bullish outlook on U.S. equities over the next 12 months, they predict that fixed income will yield the strongest returns during this period. This indicates a shift in investment strategies as investors navigate the uncertainties of the market. And confidence remains thin – the largest portion of bulls (40%) expect U.S. equities to return just 1% to 6%.

“Underscoring this cautious approach, investors think fixed income will generate the strongest risk-adjusted returns over the next year,” the report said. “While U.S. equities rank second, cash completes the top three asset classes for returns. This demonstrates investors are adopting
a defensive mindset and are attracted to the higher returns on cash after successive rate rises.”

Key findings

Key findings from the report include:

• 59% of institutional investors believe a “tail risk” event is likely to occur within the next three months.
• 38% of investors fear the imminent arrival of a major financial crisis.
• 47% anticipate that the impact of the regional banking crisis on lending conditions will impede economic growth.
• 65% expect elevated interest rates and inflation to persist for the next 12 months.
• 45% perceive U.S. sovereign debt levels as a significant challenge for the economy.
• 55% express bearish sentiments towards U.S. equities in the next three months, while 44% anticipate the highest returns from mega-cap stocks.
• 55% consider the technology sector to be overvalued.
• 51% are bullish on U.S. equities over the next 12 months.
• Investors think fixed income will generate the strongest risk-adjusted returns over the next year

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].