- 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.
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.