Wednesday, April 19, 2017

Displacements & Contrarian Thinking: BAML Monthly Fund Manager Survey

I've recently been re-reading one of my favorite financial/economic books, Manias, Panics, and Crashes: A History of Financial Crises (Kindleberger) and a passage I came across last night got me to thinking: 

"A displacement is an outside event or shock that changes horizons, expectations, anticipated profit opportunities, behavior-'some sudden advice many times unexpected.'...Each day's events produce some changes in outlook, but few are significant enough to qualify as displacements."

One could argue that we've experienced a couple of "displacements" over the last 12 months with Brexit and the US Presidential election.  Conventional wisdom in the build-up to each respective event suggested that the market would crater if Britain voted to leave the EU or if Trump won.  We now know that conventional wisdom was dead wrong on both accounts.  We saw impressive rallies on the shocking outcomes of each.  

Those that positioned for bullish moves based off these results were greatly rewarded for their contrarian thinking and it's outcomes like this that push us to always dissect the latest BAML Monthly Fund Manager Survey to uncover telling nuggets of information.  A summary of the report follows:

The first data point that stood out to us was how allocations to US equities just plunged to the lowest levels since January of 2008.  Fund managers have instead favored the cheaper/undervalued Eurozone and Emerging Markets.  Allocations to Eurozone equities have risen to 15 month highs while EM equities jumped to the highest allocation in 5 years. 

All this while cash balances rose in April from March.  Cash levels remain elevated and confirm the persistent skepticism and negative sentiment in the markets that we've touched on many times.

We continue to operate under the premise that 2017 will be favorable for US equities.  The S&P 500 continues to digest its gains from the post-election rally.  After hitting a high on March 1st of this year, the index has made a series of lower highs while holding support.  This pullback has given the market time to work off overbought conditions.  

We had a spike in the VIX recently but that looks to be easing.  Meanwhile, fund managers seem to be selling overvalued US equities in favor of European and EM stocks.  What could derail this market?  Well, we started this blog talking about displacements.  Below is what fund mangers worry about the most.  I would add North Korea/Syria/Middle East tensions to the growing list.

Some recent examples that have been used to explain the recent weakness:
  • Earnings season
  • Revised Q1 GDP lower
  • Stretched valuations 
  • Upcoming French elections
  • Concern over policy reform being pushed out
Assuming we don't get a major displacement we believe the rest is noise.