Recession could be rough for markets with heavy investor weighting in risky assets

The S&P 500 closed at 2,886.98 last week. It rose 0.5 percent over the week for its second consecutive weekly gain.

Ed Clissold, chief US strategist at Ned Davis Research, told CNBC last week that as long as the economy does not fall into a recession, “the market’s in pretty good shape”.

Clissold said that “2950 is in line with what you’d expect over the long run from the S&P”.

While he said that “it’s going to be a choppy market from here”, he added that pullbacks could be “opportunities to get in at a little bit more attractive prices as we go for the next few months”.

However, Clissold also warned that “if we start spiraling towards a recession, if we get too far gone, a couple rate cuts isn’t going to be enough to pull us out and then it could be a much rougher situation”.

A recession should indeed be a concern after Morgan Stanley reported last week that its Business Conditions Index fell by 32 points in June to 13, the largest one-month decline on record and the lowest level since December 2008 during the financial crisis.

A recession could be particularly devastating with fund investors already weighted heavily toward risky assets.

According to analysts at Société Générale, positions in equity and credit accounted for 64 percent of the investment pool covered by flow-tracker EPFR Global on a monthly basis. According to the analysts, this represents 90 percent of the maximum historical level.

This heavy weighting could be why the US stock market is now priced so high that, according to Jesse Felder of the Felder Report (via MarketWatch), investors “are likely to receive essentially nothing in return in the coming decade”.

Felder estimated the future return by comparing the total value of the stock market against the overall size of the economy, what he called the “The Buffett Yardstick”.

Felder also used margin debt as an indicator of how speculative the market has become and found “it hitting a new record high over the past couple of years”.

“In all, long-term investors are risking roughly a 60% decline to try to capture a 0% rate of return over the coming decade in the stock market, one of the worst risk-to-reward setups in history,” he concluded.