Equity markets have been rallying on renewed U.S. growth expectations and broad market optimism, but Paul Flood of Newton Investment Management warns of key risks—stretched valuations, heightened intraday volatility during earnings season, and looming liquidity concerns this August.
Flood discusses the drivers behind the recent elevated volumes across equities, retail versus institutional flow and unpacks his views on relative valuations and risks of a potential market pullback.
With Q2 earnings showing mixed intraday reactions and August’s seasonal liquidity dip approaching, he advises trading desks to tidy portfolios early to avoid elevated costs and volatility during the traditionally thinner trading period.
Interview
Jo Gallagher What factors are driving the current elevated volumes and what is your take on equities valuations?
Paul Flood Well, if we look back at Liberation Day, a lot of people derisked and believed that was the beginning of a downturn in the US economy and the equity market. As it happened, we had a really strong recovery. First of all, we rolled back some of the tariff concerns, and then we also had the big, beautiful bill and more recently, the Genius Act. And that’s led to a reassessment of the growth outlook in the United States because of that deregulation, but also the tax considerations and the benefits for front-loading and capex, which pushes growth up in the United States in the coming years. We’ve got a lot of commitments from the tariff side of things, but if that investment doesn’t come into the U.S. or at least over capacity in the United States, then perhaps some of that growth doesn’t materialize and we’ll see the equity market pull back. But for the moment, the market’s looking ahead, believes in some of these better growth dynamics are playing out in the United States, and that’s certainly driving the market higher as people look to try and catch up with the positions that they de-risked from back in Liberation Day. The concern for us is valuations are quite stretched. When we look at a cyclically adjusted P/E or a Shiller P/E, which looks at the 10-year average earnings, then you’re looking at about 38 times earnings multiples. And the last time we really seen that was back in the last tech bubble in the early 2000s. So for us, we’re a little bit concerned on valuations. But at the moment, the market’s looking through that valuation concern and looking at the growth in the coming years and front running that.
Jo Gallagher Earlier this year, retail participation was a major driver in equities activity. How much of the current flow is coming from retail versus institutional?
Paul Flood It’s hard to tell, but we do know that the retail investors are coming back into the market quite heavily, much like we saw in the meme stocks in 2021 and 2022. In fact, we believe in the options market, retail is about 35% of trading volumes, particularly in the high gamma zero day options market. On top of that, we’ve got a lot of indices hitting all-time highs. We’ve got the S&P 500 hitting all-time highs, Euro Stoxx 600 hitting all-time highs FTSE 100, FTSE All Share, and even the Nikkei 225 breaking through previous highs of 35 years ago. So it’s quite widespread across the globe. On the technical side, we’re also seeing pretty strong performance from the markets and seeing the markets really been a little bit overextended. In the Euro Stoxx 600, we’ve got about 14 companies making 52-week highs and only one making a 52-week low. 12 companies in the Euro Stoxx 600 have an RSI (Relative Strength Index) below 30, whereas we’ve got 82 with an RSI of over 70. So that’s really highlighting how extended this market rally has been. We may have to have a bit of consolidation before we move higher from here.
Jo Gallagher We’re in the midst of Q2 earnings, so how are you working with traders when it comes to managing execution and offsetting implementation costs?
Paul Flood We’re about 40% of the way through the earnings season, and we’re seeing about 64% of companies beat expectations by 2% or more. And what’s more interesting is the intraday moves and the breakdown of that composition of earnings beats versus misses. When we’re seen companies beat expectations, we’re see the share price reaction of about 2%, particularly if it’s on the top line and the bottom line. And then those companies that are missing on the bottom and top line, we’re saying a negative share price reaction of about 6-7 percent. In a number of cases, we’ve seen companies beat expectations on the earnings and be up post the earnings report, but down after the earnings call. On the other side, companies like Volkswagen reported on Friday, and we’ve seen them miss their earnings, stock was down about 2%, but then after the earnings call, the stock was up about 4%, so there’s a big divergence when companies are reporting. Given those big intraday moves, we’re working very closely with our traders. To make sure we maximize liquidity capture, but also minimize the cost impact of that. That’s really dependent on how urgent the trade is. Traders need to know whether the portfolio manager’s got some patience to be able to trade that throughout the day, utilizing dark pools, the algos, but also broker-dealer relationships to maximize the amount of liquidity we have access to.
Jo Gallagher So how should trading and investment desks prepare as we approach the month-end and we head into August?
Paul Flood Well, as we all know, liquidity tends to dry up in August, particularly in Europe, where we see lots of people going on holiday. We also have the 1st of August tariff deadline. And so that may well create a little bit of a news flow and volatility. So you want to make sure that you have tidied up portfolios going into the end of this week so that you aren’t trying to trade big positions in the lower liquidity part of the season. Particularly if there’s a bit of volatility, it may well widen a bit of our spreads. And increase the cost impact of any large trades. So for us, we’re trying to tidy up portfolios this week, making sure we get that done before the month end and before that lower liquidity month of August.
Jo Gallagher Thank you, Paul, for your insight, and of course, you for watching. This has been Trader TV This Week.
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