Wednesday, May 8, 2019

So do you sell in May and really go away?

While it is true the next six months has been the worst on average for the S&P going back to 1950 (1.48%), it usually isn't as simple as "Sell in May and go away".   As with all statistical analysis you have to look deeper into the data and not take it at face value.  We believe you have to take into context where the market is within the overall cycle.  We believe US equity markets continue to reside in a secular bull market.  We don't think it is prudent to sell your position just because the statistical data says the S&P is about to embark on the worst six-month stretch.  Yet, even within secular bull markets there are times to be more cautious than others.  Is now the time to trim lagging positions and raise some cash for potentially better entries?

There are certainly plenty of issues to make us more cautious as we enter into the most challenging period of the year.  Valuations are high but that alone doesn't warrant immediate concern.  Most economic numbers remain robust but one area of weakness has been housing numbers the last few months.  Right now the market is stuck in a headline driven market dependent on any tweet or story regarding the trade deal.  This is causing plenty of noise and volatility.  The statistical data also creates a mixed bag of results.  On one hand, the S&P's 19 week rate-of-change is at 21%.  This has been bullish going out 6-12 months as strength begets strength.  However, in the context of the current market, the S&P has been up 4 months in a row and the strongest start to the year in 32 years.  According to Ryan Detrick the markets don't have a good track record of following up on a rally of the size.  "There are four other years since World War II that the S&P was up at least 15% to kick off the year like we’re going to be this year. Three of those years are virtually flat during these worst six months of the year, the other was 1987 when we lost about 13%.  It does seem if you have some really good gains that kick off a year, it can be kind of front-ended and you can have potentially a little bit worse returns over these worst six months of the year, said Detrick.  Fundamentally things still look good ... so maybe we can get a little bit of consolidation and a well-deserved correction after a really good bounce to kick off this year.”

Last year was a bit of anomaly as the S&P experience two corrections directly off new highs.  With the S&P making new highs in May we believe this is supportive of continued strength.  Data from UBS confirms this.  "Since 1950, after stocks set an all-time high in the S&P, their subsequent six-month return has been 4.7%.  The data also show that large pullbacks have been less likely after markets have put in records.  The market has just 11% of the time declined by more than 5% over the six months following an all-time high, compared with 18% of the time otherwise.”

Markets are made by various opinions about price on a daily basis.  If we take a step back and look at the data presented there are cases to be made for the bulls and bears.  However, we prefer to look at the data relative to the cycle.  The next six months is a more challenging period but that doesn't mean we need to be bearish.  We do believe the next four months won't be as easy as the previous four considering the magnitude of the rally.  Yet, we remain bullish maintaining our core positions but looking for better entries as we enter the seasonably slow part of the calendar as we think the back half of the year can finish strong. 

Wednesday, March 20, 2019

Sentiment still pessimistic

The March BAML fund manager survey gives us some insight into fund managers positioning and sentiment.  The key takeaway is fund managers remain skeptical of this rally as cash balances remain high and allocations to stocks dropped to their lower level since September 2016.  Below is a recap of this month's main themes:

BofAML March Global Fund Manager Survey
"Pain trade" for stocks is still up: in the BofAML March Global Fund Manager Survey (FMS), profit expectations rose, rate expectations fell, and cash levels fell from 4.8% to 4.6%yet allocations to stocks dropped to their lowest level since Sep '16; there is simply no "greed" to sell in equities.
Growth & EPS expectations rose for 2nd consecutive month: but China & corporate debt concerns linger: the biggest "tail risk" for investors is "China slowdown" (not "trade war");asked what companies should do with cash flow, 46% of respondents said "improve balance sheet", 29% said "increase capex" (lowest since Oct'09), 18% said "increase buybacks".
Interest rate expectations fell: more than 1/3 believe the Fed hiking cycle is over53% say short-term rates will be unchanged or lower over the next 12 months, and FMS bond yield forecasts are now the lowest since Jul'12a big reason cyclical stocks remain shunned.
Asset allocations look pessimistic: investors are long defensive assets that perform well when growth & rates fall, and short cyclical assets that perform well when growth & rates rise (Chart 1); allocation to bank stocks dropped to the lowest since Sep '16.
Crowds & contrariansthe most crowded FMS trade is short European stocks; overvaluation of US$ is the highest since Jun '02; relative to 20-year FMS history investors long cash;"long stocks-short cash""long EU-short EM""long industrials-short REITs" are all contrarian.
Rules & toolsBofAML Bull & Bear Indicator stays at a neutral 4.7; FMS cash rule & FMS volatility rule say "long risk"; FMS relative value models more defensive.

After a 20% move off the December lows in the S&P 500, fund manager still find themselves underwhelmed and under exposed.  There remains no euphoric greed even after such a strong move.  This bodes well for the bulls and the pain trade continues to haunt the bears.  Fund managers favor defensive names and cash even as their expectations for growth and profit improve.  

While 38% of fund managers say they think the Fed is done hiking rates and the fed funds futures markets are pricing in 13bp of Fed rate cuts in the next 12 months.  This still doesn't make managers bullish as equities cannot catch a bid with global equity allocation the lowest since September of 2016.  Global equity allocation stands at just 3% overweight and has only been negative once in the past 6 years.  

A slowing China economy takes the top spot as the biggest tail risk, followed by a trade war and corporate credit crunch.  These worries seem to be weighing on investors appetite for risk as only 30% of fund managers are net long equity markets, which is the lowest since December 2016 and a massive reversal from 55% net long in September 2018.

It is easy to understand why fund managers are pessimistic.  59% of FMS investors are bearish on both the growth and inflation outlook for the global economy over the next 12 months, the highest since Oct'16, cementing the return of secular stagnation as the consensus view amongst FMS investors.  This also explains why investors are only 3% overweight global equity allocation.  This is the lowest since Sept '16, a massive drop from 31% overweight as recently as Nov '18 as investors turn skittish on equities despite global stocks +12% YTD.  FMS equity allocation has only been negative once (Jul '16) since 2012.

Since the market top in October there has been a battle between bulls and bears and the recent survey underscores the gloomy outlook for the bears.  There is a divergence between sentiment and price which should break the market in a clear direction.  Will the bears win, and the trend turn lower on the back of slower growth and over-valued dollar?  Or is there something under the surface that has propelled this market higher in a ferocious rally straight off the bottom.  A case can be made if the bears throw in the towel and increase their allocation to equities, the pain train will endure.  We remain in the bullish camp as the price appreciation should continue with further gains.  However, that doesn’t mean there won’t be downside volatility and choppy frustrating trading ranges.  We just don’t believe the markets are ready to implode as the bears predict and hope.  The sentiment data favors the bulls and leaves plenty of room for the upside and euphoria and greed to set in as the rally continues.