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A stock-market rally built on the fear of missing out

Investors on the sidelines have missed big gains so far in 2013.


After breaking records in what turned out to be a terrific first quarter, U.S. equities retreated modestly last week in the face of some discouraging economic numbers in North America and Europe. Most other major markets also took it on the chin, no doubt in part because of the bizarre nuclear sabre-rattling of North Korean leader Kim Jong Un and the outbreak of a new strain of bird flu in China.

We're bound to see more of these market jitters surface in the weeks ahead, because most investors still harbour doubts that the world – and more specifically, the U.S. – is firmly on track toward a sturdy recovery. Friday's dismal job report deepened those worries.

In fact, the entire rally has been fuelled more by a fear of missing out on the rally than by any confidence that the economy minders know what they're doing. Call it the accidental bull, driven by reluctant money managers caught with too much money on the sidelines when stocks began their upward swing last summer and determined not to let that happen again.

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That's the picture painted by Phillip Colmar, a strategist with Montreal-based MRB Partners. A lot of people were caught playing defence when U.S. equities rebounded, Mr. Colmar tells me. "They kept waiting for the 10-per-cent correction that didn't come. They stayed out and underperformed their benchmarks."

That's the sort of performance that can turn a portfolio manager into a jobless statistic in no time. So when the market got off to a strong start in January, the money handlers were better prepared. "People were frantically pushing from an underweight [position] toward a benchmark weighting, so they wouldn't underperform again."

It's a trend that continued to the end of the quarter, as cash continued pouring into U.S. equity funds from investors "who were absent for much of February and March," reports EPFR Global, which tracks international fund flows. Last week, though, U.S. funds posted their smallest net gain in five weeks.

"There's a lot of skepticism about the sustainability of this recovery and the unorthodox [monetary] policies and how this turns out," Mr. Colmar says from his midtown Manhattan office. "Multi-asset portfolio managers have moved toward benchmarks, but they're doing so very defensively."

That means sticking close to home and avoiding more economically sensitive stocks. "Because they're nervous, the equities they've chosen to buy have been ones that are home-biased and more defensive [with stable cash flows and high dividends] rather than the cyclically related names. And that's why defensives have outperformed."

Mr. Colmar is an astute analyst of bond, currency and equity trends who bases his assessment of market sentiment on direct conversations with participants – about 120 institutional investors in the past month alone.

After a recent excursion to visit clients in Amsterdam, Paris and London, he concluded that the mood, at least in London, was becoming less bearish, though not quite as upbeat as New York. Skepticism still forms the investment backdrop in both markets.

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The euro area, by contrast, is still riddled with pessimism, although he is convinced the Cyprus fiasco will prove to be "a one-off event" that will be successfully ring-fenced. "It's going to be noise at the end of the day. But at least for a week, it was certainly a very nervous piece of noise."

Here's Mr. Colmar's take on how the rest of the year could unfold for equities.

If the key economic data turn out to be as lousy as the latest job numbers, "there's a lot of skeptical money that will move to the exits." But here's the good news. The folks who manage a large chunk of that money are still trying to get back to their benchmarks, so it might take some time for any real flight to materialize. And on the flip side, if the global economy strengthens – as MRB is forecasting – investor confidence will gradually build.

To that end, he predicts the U.S. economy will produce some surprises to the upside and China's soft landing will be more accepted by the markets as a positive development paving the way for a more durable global recovery.

All that, in turn, means there will still be lots of room for more cash to flow into equities. If that occurs, the next phase of the reluctant bull would encompass cyclical stocks and emerging markets. Mr. Colmar is a particular fan of South Korea and other tech and manufacturing centres in emerging Asia.

And as long as the skeptical money continues to play defence in the home market, "I can get good value in healthy parts of the world in the equity space. I don't have to buy the weaker parts."

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Phillip Colmar on the Cypriot mess:"I understand Germany was trying to make a political statement coming up to the elections. ... It was a German-Russian debate. But you don't play that out in the middle of the European financial system and put it at risk."

On Japan's efforts to reduce the value of its currency:

"They could probably push it back in line with fundamentals, to a certain extent. But it would be hard to depreciate the yen substantially, just because everyone in the world is targeting quasi-zero per cent interest rates."

On commodities:"In the near term, we expect commodities to do well, because investors' growth expectations will improve. From an intermediate to longer-term perspective, we see the world growing much slower than it did in 2008. So commodity demand is probably going to be half of what it was before 2008."

On contrarian investing:

"Everyone wants to be a contrarian investor. The truth is that contrarian investing only works at extremes. During the mid-points, it's not very useful. There isn't enough confidence in any one theme to build extreme pricing into almost anything else [apart from safe haven bonds]."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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