The 'fear factor' that is spooking investors' sentiment

WHAT Brexit?

Even though sterling has sunk to a 31-year low against the greenback, there are few signs of an outbreak of fresh turmoil in financial markets.

The Straits Times Index, for instance, is now trading higher than where it had closed on June 23, the day when Britain went to the polls to decide whether to stay in the European Union or not.

Yet, even with the improvement in investors' sentiment, there is precious little to cheer about in the equities market.

Major Asian bourses are still down on the year, with losses ranging from a modest 1 per cent in Singapore's Straits Times Index to a more serious 17.68 per cent in Tokyo's Nikkei-225 Index.

The US stock market is not faring that much better either. For all the hullabaloo about Wall Street swinging back into record high territory, the Dow Jones Industrial Averages and the S&P 500 are both up only about 3 per cent this year.

Investors are not exactly fired up about stocks this year.

They have been taking money out of the stock market and pouring it into the bond market. This is despite yields falling to extraordinarily low levels for bonds due to the actions taken by major central banks to pare interest rates in some cases to negative levels.

The OCBC Global Fund Flow report notes that investors have so far poured US$76.8 billion into bond funds this year, dwarfing the US$55.8 billion which they invested into such products for the whole of last year.

It begs the question: Investors are urged to buy stocks because market analysts reckon that the US central bank is likely to keep interest rates on hold for the foreseeable future because of the uncertainties kicked up by Brexit.

Since stocks - especially the defensive ones - pay a higher dividend than bonds, the reasoning goes that investors should be taking money out of the fixed income market and putting it to work in equities where they would get a better return.

But the fact is that the yield on the 10-year US government bonds - at 1.28 per cent - is now 0.3 percentage point lower than where it was on June 23, while the yield on 10-year bonds in Germany and France are basically zero.

This suggests that most investors are quite happy to stay risk-averse and sit pretty on assets which pay out a negligible return.

In Singapore, we see an even more unusual phenomenon.

Investors, who will not touch the shares of certain listed firms with a 10-foot pole, have no qualms snapping up the high-yielding bonds issued by some of these same companies.

Surely, they should have paused to ask why these companies are offering such an attractive yield on their bonds in a low-interest rate environment. If their business faces any problems, for whatever reason, and their share price plunges, the likelihood is that they will also be unable to keep up with the coupon payments on the bonds.

But the desperation to earn more yield, so as to avoid eating into the principal, has made some risky investments too enticing for investors to pass up.

New York Times writer Carl Richards summed up the contradictory behaviour displayed by investors as a collective anxiety over money. He wrote: "People are scared and at the root of their fear is money, or rather the lack of it."

Financial anxiety isn't confined to the poor alone.

Even the US middle class is struggling to make ends meet with a US Federal Reserve survey showing that 47 per cent of its respondents could not come up with US$400 to cover an emergency unless they borrow or sell something.

Said Mr Richards: "Look, people are scared. They are scared they are going to lose their jobs to a robot. They are scared that the factory down the street is going to move overseas. They are scared that their children won't be able to afford to go to college."

This not only helps to explain the anomalies in the financial markets where both momentum-loving equity investors and stodgy fixed income investors are bullish on the market, but also explains some of the outlandish results that have emerged in the current US election cycle.

Said Mr Richards: "When we get scared, the natural reaction is to look for someone to blame, someone to fight or someone who can fix things. The question at the heart of this election just might be: Who among the candidates will provide the necessary conditions for us to address our financial fears?"

Indeed, it may be this very anxiety that led to millions of erstwhile Labour voters in Britain to desert the advice given by their leadership to vote in favour of Brexit, tired as they were of the years of savage economic austerity that were imposed on them after the global financial crisis.

In normal times, such fears in the world's No.1 economy will not be sufficient to trigger a recession. But in a world of very low inflation and very low interest rates, people only have to cling a little more tightly to their money to cause an economic slowdown.

It is this fear which we may have to watch closely as we try to decipher which direction the stock market is likely to take going forward.