Tuesday, June 13, 2017

Did you just miss a buying opportunity?

One of our favorite tools for getting a read on the sentiment and psychology of the market is the monthly fund manger survey (FMS) from BAML.  Below are the key takeaways straight from the monthly report:
  • June FMS shows Fed tightening at time of peaking macro momentum, high cash levels, crowded Nasdaq and record # investors saying equities “overvalued” (>1999bubble highs)
  • The FMS suggests “preventative hike” to subdue Wall St speculation best describes likely FOMC action this week; but we say too little, too late to prevent Icarus
  • June FMS cash levels up from 4.9% to 5.0% (>10-year average of 4.5%); means FMS cash too high for “Big Top”
  • Global growth expectations @ 39% vs 62% in Jan...macro momentum has peaked; so June FMS sees defensive rotation to staples, utilities + largest drop since Jun’10 in allocation to commodities
  • Fed hiking 3rd time in 6 months (after hiking once in 10 years) but contrarian bond
    bulls on rise: just 9% of FMS forecast lower/flat bond yields last Dec, now 20% do
  • 3/4 say internet stocks expensive or in bubble: 57% investors say “expensive”, 18%
    “bubble-like”, 15% “fair”, 1% say “cheap” (Exhibit 1)
  •  #1 “crowded trade” in June = long Nasdaq (jumped from 26% to 38%), #2 long EU
    equities, #3 long US/EU corporate bonds
  • But contrast with ‘99 bubble (record June FMS views of “excess valuation” not
    coinciding with fall in cash levels) shows less “irrational exuberance”
  •  And comparison with ‘99 bubble (“excess valuation” is coinciding with high global
    profit expectations) reminder that while vulnerability high, missing combo for
    immediate “Big Top” is higher yields/falling EPS
  • Contrarians sell Europe, banks, tech, buy UK, resources, commodities, bonds
We remain bullish in our thesis and this survey has some interesting contrarian data to support our outlook.  Below are a few items we wanted to highlight.  We continue to hear from pundits that this market is excessive and overvalued as a record number of investors say that equities are "overvalued."  75% say internet stocks are expensive or in a bubble even as it remains the #1 crowded trade.  However, cash levels are up from 4.9% to 5% and there was a rotation into the defensive sectors of staples and utilities.  Outside of valuation metrics we can't find many indicators suggesting sentiment is excessive.  It is quite the opposite as this remains an unloved bull market that continues to climb the so-called wall of worry.

For this market to get irrational we are going to need to see more proof in underlying data.  While Nasdaq stocks may have gotten ahead of themselves the market quickly eroded some of that confidence last Friday and yesterday.  The NDX corrected 4.5% from peak to trough in less than 2 trading days.  These types of shakeouts should be expected in a strong trend and a reminder that we aren't likely to get the slow constructive pullback that everyone wants.

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. 

To include all data points going back to the inception of the NDX (1985) we looked at all 2% down days and then also compared them when they were above the 200 day moving average and below.  The data suggest strong trends persist when the NDX has a 2% down day and above the 200-day moving average (as we are now).

One thing we have talked about and continue to monitor is the length of the current move in the S&P without a 5% correction.  The S&P 500 has now gone 151 days without a 5% correction.  This is the second longest stretch since 2009 and is fast approaching the record of 155 days from Feb-Sept of 2014 since the 2009 bottom.  Nautilus Research put out a nice piece on the current streaks in the NDX and S&P that also confirm we are long in the tooth.

We know this market is extended and due for a pullback at some point.  As we witnessed with the NDX Friday and Monday these pullbacks can come out of nowhere and happen fast.  We expect it to be no different next time.  However, we are still bullish and continue to see mild sentiment as a potential catalyst for further gains.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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