Greed is making a comeback on Wall Street.
Just six weeks ago investors were on the verge of a full-blown panic. Fears about China’s economic turbulence and vague Federal Reserve policy gripped the financial markets.
The deep concern caused the Dow to plummet by an unprecedented 1,000 points on August 24 before sending the market into correction mode.
But fear is quickly fading on Wall Street. The Dow is at a two-month high and the S&P 500 has clawed its way back above the 2,000 threshold.
Furthermore, for the first time since early July investors have poured money back into both stock and bond funds globally, according to Bank of America Merrill Lynch research on weekly fund flow data.
It “signals a turn in risk-off sentiment,” Michael Hartnett, chief investment strategist at BofA Merrill Lynch, wrote in the report.
The markets are betting “low” growth, earnings and interest rates are “here to stay, but no recession,” he wrote.
That’s why CNNMoney’s Fear & Greed Index is now sitting comfortably in “neutral” territory. It’s a huge improvement from just a month ago when it was flashing “extreme fear.”
Junk bond get some love
But investors aren’t just dipping their toes back in the water. They’re jumping into the deepest waters.
Junk bonds experienced weekly inflows of $2.6 billion — the largest surge in eight months. That’s despite concerns from Carl Icahn and others that this notoriously risky corner of the bond market is in the midst of a bubble.
Emerging markets have been in turmoil because of the plunge in oil and other raw materials and also fears that people will pull money out from investments overseas when the Fed raises rates.
However, in the latest week investors threw caution to the winds and poured $400 million into emerging market debt funds. That was the first increase in 12 weeks and biggest in five months, BofA said.
“It’s clear that investors are putting money to work again. They’re doing it selectively — but they’re doing it,” said Peter Kenny, an independent market strategist and founder of Kenny’s Commentary.
No more flight to safety
Investors are also showing a willingness to step away from the relative safety of government debt like U.S. Treasuries. BofA said funds that invest in U.S. government bonds actually experienced a dip for the first time in 15 weeks.
“That speaks to investor confidence. We’ve likely seen the worst we’re going to see in the near term,” said Kenny.
China jitters fade
So what drove the change in sentiment?
First, fears about a crash landing in China’s economy have eased a bit. The Shanghai Composite has surged 8% over the past month alone. It’s back to being in the green on the year.
“It’s really a China-centric story. That narrative was driving a lot of fear into the market,” Kenny said.
At the same time, commodities have stopped collapsing. Copper and silver prices have rallied this month and crude oil recently climbed above $50 a barrel for the first time since July.
Investors are also bargain hunting. While stocks are hardly cheap, it’s clear the late summer selloff created buying opportunities that some seized on.
Could D.C. ruin the party (again)?
No one knows how long the risk trade will last. It could persist through the end of the year, giving investors’ portfolios a much-needed Santa Clause rally. Or it could be one crisis away from vanishing.
Bespoke Investment Group is betting on the latter, urging clients to dial back on risk due to the unlikely but still real chance of a debt ceiling crisis, just like in 2011.
“We do not like the sounds coming out of D.C.,” Bespoke wrote in a note to clients on Friday. “While we don’t think that a debt ceiling crisis is ‘likely,’ if it does take place the impact on markets could be enormous.”
