Thursday, August 17, 2017

August Fund Manager Survey

The monthly fund manager survey (FMS) from BAML is out and always offers an interesting view on the global investing landscape.  This month's survey doesn't deviate much from prior recent months.  Fund managers continue to worry about the same set of issues while their positioning continues to be overweight the same areas.  Cash levels remain too elevated to set conditions for a market top yet growth expectations continue to trend lower.  Below are the key takeaways straight from the August survey.
  • Bottom line: FMS cash levels high, fail to trigger risk “sell” signal from BofAML’s Bull & Bear indicator; record highs in investors forecasting “Goldilocks” and saying stocks“overvalued”; negative inflection point in FMS profit expectations our key takeaway.
  • Aug cash unchanged at stubbornly high 4.9%; asset allocation to cash rises to 9-month
    high; but cash & overvaluation fears aside, FMS positioning remains broadly pro-risk,
    pro-cyclical (i.e., long Eurozone, EM, banks, equities, short US/UK, energy, bonds).
  •  Ominous inflection point in profit expectations indicator (was 58% in Jan, now 33%); FMS profit outlook correlates with PMIs, equities vs bonds, HY vs IG bonds, cyclical vs
    defensive sectors (Exhibit 1); further deterioration likely to cause risk-off trades.
     
  • Note recession (53%) would be biggest surprise for FMS investors in next 6 months,
    then “inflation” (25%); least surprising would be “equity bubble” (34%); biggest “tail risk”
    deemed to be Fed/ECB policy mistake, then bond crash & North Korea.
     
  • Anglo-Saxon political angst reflected in lowest allocation to US stocks since Jan’08, to
    UK stocks since Nov’08; in contrast EM & Eurozone remain consensus longs (note China
    3-year GDP estimates up to 5.8%, highest since Apr’16).
     
  • Top sector overweight is banks (record high), followed by tech (though contrarians note
    tech allocation fell to 3-year low); energy allocation drops to 14-month low; allocation to
    staples/telecom/utilities (“defensives”) still low, but starting to pick up.
     
  • Contrarian trades: long utilities vs. banks, long energy vs. industrials, long materials vs.
    tech, long UK vs the Eurozone. 
What continues to be a trend is that fund managers maintain a fair amount of cash while favoring high quality and value over growth.  They continue to view the US markets as overvalued and allocations to US equities fell to a net 22% underweight.  The last time they were so underweight US stocks was in Jan 2008.  Meanwhile, allocations to Eurozone equities rose to net 56% overweight and EM equity allocation rose to net 39% overweight.  Relative US equity positioning versus the rest of the world sits at -60% which is the lowest since April 2007 and 1.3 std dev below its long-term average.   In an interesting twist, allocation to global technology falls to net 24% overweight which is a 3-year low while bank allocations hit a record high.


The S&P has currently pulled back 2.1% from its recent highs.  One would think the strength in the trend this year would have sentiment peaking and hitting extremes.  Yet after every little 1-2% down move we get the opposite in which the fear indexes spike and sentiment flips bearish.  This leads us to believe that most participants still don't fully believe in this bull market and are ready to sell fast at the first sight of weakness.  Fund managers continued high level of cash confirms this and a look at the CNN fear and greed index shows current sentiment is fearful.  The recent spike in put/call ratios and vix term structure further displays the lack of conviction in the current market. 

A few things we're watching to keep us honest is the weakness in small caps along with the deteriorating breadth.  New lows in the S&P 500 (middle panel) have hit the highest levels since June 2016.  This is higher than the pre-election weakness we saw last November.  The % of stocks above their 50-day moving average (bottom panel) continues to lag.  This isn't as concerning as this measure has trended lower for over a year now but it is something we keep an eye on.  We would prefer to see new highs in the markets accompanied by a fresh breakout in breadth.  In the second chart below we see that 3 out of 4 of the big index's remains in a solid uptrend and above their corresponding moving averages.  The one weakness is in small caps as the Russell 2000 has pulled back 5.9% from the July highs, and given up its 2017 gains, while testing longer-term moving averages.



As we discussed in our last post seasonality isn't on the side of bulls the next few months.  Couple that with the current length without even a 3-5% pullback and the worsening breadth keeps us with some cash on the sidelines while maintaining core positions from a tactical standpoint.  However, what keeps us bullish overall is how quickly the market prices in fear on every little dip as there remains plenty of angst and skepticism.  Sentiment remains bearish and is a nice contrarian indicator as this remains one of the most unloved bull markets.  With allocations to US equities the most underweight since January of 2008 and tech allocations at a 3-year low, we would favor to put cash to work after any pullback takes hold. 

Wednesday, August 9, 2017

Dog Days of Summer

Looking at August Data:
  • Last 20 years: August ranks dead last in monthly performance with an average loss of 1.31%
  • Last 20 years: The average daily trend starts weak and finishes weaker
  • Last 20 years:  The August through October 3-month rolling return is typically weak with an average gain of just 0.02%
  •  Last 20 years:  Further, August through September is the worst 2-month stretch on the calendar as both months have averaged losses.
  • Since 1950:  August is second to last in monthly performance with an average loss of 0.09%
  • Since 1950:  If the S&P is up greater than 10% through July, August has an average loss of 0.83%
  • Since 1950:  If the S&P is up greater than 10% through July and July was positive, August has an average loss of 0.24% with an average gain of 5.78% for the rest of the year






This leads us to the question of where does the market go from here?   If we knew with certainty, we'd all be a lot wealthier...  Without the superpower of clairvoyance, we choose to look at historical data and to help us make educated bets.  

As we've mentioned before, we think the market remains firmly in a secular bull market.  Yet with all bull markets there are always pullbacks and corrections.  Per this Ryan Detrick tweet the current streak of 9 months without a 3% pullback for the S&P is the second longest since 1950.  This confirms our own data that we touched on in our last blog post about the length without a 5% correction.  Does this mean we are guaranteed to get a correction any time soon?  No, but the historical data makes the case that the market is past due and to be on alert for a potential fade.  

One of our favorite weekly reads is from Jeff Saut at Raymond James and his latest investment strategy letter had some great wisdom: 

The call for this week: The D-J Industrials have made new all-time closing highs for eight straight sessions and have made 34 all-time highs year-to-date. Still we keep hearing, as we have for years, “There is a stock market crash coming soon.” However, history shows stocks NEVER crash from new all-time highs without giving participants a chance to adjust portfolios. In 1929 the Dow made a new all-time high on 9/3/1929, but the crash came months later (October 28/29th). In 1987 the Dow made a new all-time high on 8/24/87, but the crash arrived on October 19, 1987. Moreover, as our friend Tony Dwyer (Canaccord Genuity) writes: 

Think about all the non-recession 10%+ corrections over the past 25 years. Don’t they all start with an overbought condition, too much optimism, and a sense that a correction is overdue and should be bought? How then is one to determine if the correction would likely be temporary or something more significant? History serves as a great guide – even in the current cycle. Significant corrections, even if temporary, come with the perception of a probable recession. The two major corrections over the past 7 years (2011 & 2015-16) were associated with a global crisis that could have put the sluggish U.S. economy into recession. There is no sign of any significant deterioration in the (1) global synchronized recovery, (2) U.S. economic reacceleration, or (3) credit market environment that should create the fear of recession. As a result, we expect any correction to provide a better entry point for a move to our 2018 S&P 500 (SPX) target of 2,800 with a focus in the “pro-growth” sectors. 

In summary, we are of the view that barring any major geopolitical risks, we want to be buyers into weakness.  We have recently raised some cash as we head into the most challenging 2-month stretch of the last 20 years to hopefully exploit such an opportunity.  Couple this historically weak period with the length and persistence of the current up-move without even a mild pullback and we believe there may be better opportunities for entry over the next few months.  

Wednesday, July 19, 2017

July Monthly Fund Manager Survey

The monthly fund manager survey (FMS) from BAML is out and always contains an interesting view on the global investing landscape.  This month's survey doesn't deviate much from last month's.  Fund managers continue to worry about the same set of issues while their positioning continues to be overweight the same areas.  Cash levels remain too elevated to set conditions for a market top yet growth expectations continue to trend lower.  Below are the key takeaways straight from the July survey.


  • Bottom line1. cash levels still too high for "big top"; 2. too many see Fed as likely negative catalyst while inflection lower in growth/EPS estimates being ignored; 3. energy>banks, US>Eurozone, commodities>cash (Exhibit 1best contrarian trades
  • July FMS cash levels dip from 5.0% to 4.9%; but cash remains well-above 10-year average of 4.5% & allocators very OW the asset class(Exhibit 1)…cash too high for "big top"
  • 3 most crowded trades: long Nasdaq (38%), long US/EU credit (15%), long Eurozone equities (12%)…means ECB most likely central bank to spark global "risk-off"
  • 3 biggest tail risks: crash in bond markets (28%), Fed/ECB policy mistake (27%), China credit tightening (15%)…central banks seen amuchbigger risk (the "red herring") than EPS, and yet…
  • …clear inflection point lower in FMS growth/EPS expectations; 38% expect stronger growth vs. 62% in Jan41% expect stronger profits vs. 58in Jan
  • July rotations: investors bought Japan, healthcare, materials, commodities; investors sold tech (68% say US/global internet stocks "expensive"), UK, discretionary, industrials
  • July positions: big longs in banks (knocks off tech as #1 global sector OW), Eurozone, EM; big shorts in UK, energy & US stocks (last time UW in US stocks larger was Jan'08)
Banks have overtaken tech as the most overweight global sector as 68% say US/global internet stocks are "expensive", 12% say "bubble-like", and 15% say "fair".  With the Fed on a hiking cycle and the potential for global tightening underway we understand the overweight towards banks.   However, for the third straight month "Long Nasdaq" remains the most crowded trade.

Meanwhile, sentiment remains in check as cash levels are elevated and the biggest reason for holding extra cash is "Bearish views of the markets".  This bearish stance coincides with expectations for "faster global growth" falling to 38% in July, down from 62% in January.  Fund managers continue to lose faith in profit and earnings expectations as they sink to the lowest percentage since the US election.  Additionally, 17% say corporate balance sheets are over-leveraged, the most since April 2009. 

 Exhibit 2 Evolution of Global FMS "most overweight global sector"5229154ce8d74d64af24807447bef23f.svg
 
  Exhibit 3 Evolution of Global FMS "most crowded trade"
637bdb711fe94c75b5138d3e0f706a09.svg

Exhibit 6: If you are holding consistently higher levels of cash in recent quarters, does this reflect:
c9edb3c78ea0424a9ea389611eadc5b4.svg
 Exhibit 8How do you think the global real economy will develop over the next 12 months?2eb5703955674dfe916529b3e9939829.svg

With the news that Republicans could not pull together enough support in the Senate to pass a health care overhaul this will only put more pressure on growth expectations.  Much of those assumptions had been built on the idea that growth will come with less regulations and lower taxes.  This theme could be pushed out further into the future with the failure to pass an Obamacare replacement.  Sentiment could take a hit as traders fear tax reform will not take place this year. 

The S&P 500 has now tied the second longest streak in history without a 5% pullback having gone 173 days without such a drop.  The index first notched this marker in 2006-2007.  The only longer streak was the massive 296-day span during the roaring bull market of the 90's from 1995-1996.

In a previous blog post we commented:

"Below we looked at all instances since 1990 where the NDX closed down more than 2% after having just made a new 52-week high on the prior trading day.  From the data, the very short-term (5 days) is neutral but going out further there is a bias to the upside.  It shouldn't surprise anyone if we make new highs sooner than expected.  The one caveat in the data below is many of the data points happened during the super bull of the late 90's.  If we included the crash of 87 the results are worse but it was such an outlier we chose to ignore.  Regardless we thought it was interesting enough to present." 

Since then all markets have made new highs or tested highs.  The trends remain favorable to the bulls as all moving averages are pointing strongly higher.  We still favor the trend and positioned bullishly but also acknowledge there will/should be pullbacks along the way.  With seasonality setting up for a potential increase in volatility along with the excessive length without a 5% pullback, we are comfortable being patient with some cash on the sidelines looking for better entries as we navigate earnings season.