September 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 provides some new data points but doesn't deviate much from that last few 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 and US equity underweight is at a 10-year high.  Below are the key takeaways straight from the August survey.

• 3 talking points: 1. FMS says markets can remain in "Icarus" upside mode for risk assets, 2. "mean reversion" has become contrarian as investorscut expectation of higher bond yields; 3. US equity UW at 10-year high, EM OW at 7-year high as US$ bulls vanish
• On Icarus: Sept FMS shows cash levels high (down from 4.9% to 4.8% but >4.5% ave past decade), largest jump in "taking out protection" in 14 months, lowest OW in equities since Dec'16 & smallest UW in bonds since Nov'16…no irrational exuberance yet
• On mean reversion: rotation back to QE themes of scarce "growth" (e.g. tech - Exhibit 1) & "yield" (e.g. EM), away from "value" (Japan, banks) asinvestors shun mean reversion, slash expectations for "much higher" bond yields (+26% last Nov to 5%); energy ("value") UW largest since Mar'16, utilities ("yield") UW smallest since Aug'16
• On macro: FMS growth optimism continues to sag (+62% in Jan to +25% today) but profit hopes rose a tad this month (+34%)…greater conviction in EPS than GDP; notable divergence in FMS perceptions of fiscal policy ("easy") vs. flatter yield curve (see Exhibit 10) shows US tax reform most obvious catalyst for steeper US curve
• Most crowded trades: 1. long Bitcoin (up $1000 to almost $5000 early Sept), 2. long Nasdaq (up 20% YTD), 3. short US$ (-11% YTD); note longUS$ was most crowded trade as recently as Mar'17 - Exhibit 2)
• On risk: biggest tail risk is North Korea by some margin (tallies with Sept drop in Japan equity exposure), followed by Fed/ECB policy mistake; recession in next 6 months deemed biggest potential surprise, an equity bubble least surprising
• On regions: biggest UW in US stocks since Nov'07, biggest OW in EM stocks since Dec '10; investors have not been this UW the US relative to EM/Eurozone since 2007; weak US$ big factor (US$ now most "undervalued" since Dec'14)
• Contrarians would be: long US$, long US energy, short EM tech, long Japan banks, short Eurozone discretionary/banks

One of the biggest changes this month has to do with evolution of tail risk and the fear of a conflict with North Korea.  This has become the top rail risk in September by a wide margin.  This coincides with fund managers belief that volatility is the most undervalued asset which dwarfs the next asset by far.  Cash remains elevated and this makes sense with fund managers heightened sense of angst combined with expectations for faster global growth falling again in September as it sits at the lowest level since October 2016.  Meanwhile fund managers continue to increase their hedges as equity markets hit new highs.  Hedges had their largest jump in 14 months.  Bitcoin makes its first appearance as this tops the list of most crowded trades.  Lastly, allocation to US equities falls to net 28% underweight from net 22% underweight last month.  The last time the underweight in US was larger was in November 2007.  

  
In summary, fund managers have been selling US equities into strength while increasing their hedges.  After a healthy run in equity markets managers are positioning their exposure in cheaper global markets yet continue to favor growth sectors over defensive ones.  With the historically weak August and September about to wrap up we are entering the seasonally strong 4th quarter.  In the short term we have internal market indicators flashing overbought conditions as US equities have hit new highs.  As we discussed in our last blog september stats to consider, we showed how the back half of September is usually weaker.  We will be watching how the markets react to the FOMC announcement today along with any fresh data out of the Fed.  In turn, tactically we have used the strength to lighten up some positions but we maintain that any weakness should be bought as we continue to believe this market will finish the year strong.  We'll leave you with one stat that is extremely impressive from Ryan Detrick.

"Since '28, S&P 500 higher each month May - Sept ... 4Q has never been lower. Up 6 for 6 with an avg return of 9.6%. Could happen this year."

Some September Stats To Consider

Looking at September Data:

• Last 20 years: September ranks second to last in monthly performance with an average loss of 0.61%

• Last 20 years: The average daily trend peaks mid-month and finishes weaker

• Last 20 years: September is the second most volatile month only behind October

• Since 1950: September ranks last in monthly performance with an average loss of 0.51%

• Since 1950:  September is the fourth most volatile month and is only higher 44.78% of the time which is the worst probability of any month

• Since 1950:  If the S&P is up for the year and August is positive, September has an average loss of 0.17%

With the above data considered, lets look to see what September may have in store.  We know that September's typically tend to bring about weakness in stocks with higher volatility.  In fact an interesting stat on volatility from the always reliable Ryan Detrick says that: 

"The worst September ever for the S&P 500 resulted in a 30% drop in 1931. In fact, no other month has had more 10% drops than September at seven. Interestingly, January is the only month that has never been down 10% or more."

September 2017 has plenty of story lines that could lead to an unpredictable month and potential for a pullback.  As always the geopolitical climate remains hostile and has been the driver of higher volatility the last several weeks.  Since the beginning of the year the VIX index has averaged around 11.50.  However since the start of August the VIX has twice spiked above the 15 level.  Are we due for higher sustained volatility in the coming months?  We don't know the answer to that but September and October remain the two most volatile months in the last 20 years.  Couple that with a Fed meeting, Harvey cleanup, Hurricane Irma heading towards Florida, the debt limit showdown and a host of other headlines, and the end of September could certainly be interesting.  Now we don't expect much out of the Fed meeting with only a 1% chance of an interest rate hike but with the partisan nature of government these days the debt ceiling debate will keep us on our toes.  

Jeff Hirsch of Trader's Almanac has some interesting commentary about month-end:
  
"Although the month has opened strong 13 of the last 22 years, once tans begin to fade and the new school year begins, fund managers tend to clean house as the end of the third quarter approaches, causing some nasty selloffs near month-end over the years. Recent substantial declines occurred following the terrorist attacks in 2001 (Dow: -11.1%) and the collapse of Lehman Brothers in 2008 (Dow: -6.0%). Solid September gains in 2010; DJIA’s 7.7%, S&P 500’s 8.8% were the best since 1939, but the month suffered nearly the same magnitude declines in 2011, confirming that September can be a volatile month."

If we turn our attention to the technicals and sentiment we can start to paint a clearer picture.  While we remain bullish overall we have continued to be tactically cautious in the back half of summer and into September.  With some cash on the sidelines and maintaining our core positions, our patience has been rewarded as the S&P has stalled since mid-July while experiencing the largest intra-year drawdown of 2.9% during August. 

One thing we are monitoring is the negative divergence in breadth as the S&P consolidates.  The leadership has narrowed and for the market to sustain new highs it will need to be accompanied by a fresh bout of momentum.  In what has been a most unloved bull market, the S&P has now had the second longest streak without a 5% pullback since the 90's.   It has been 209 days since the last 5% fall and has blown past the streak set during 2014's strong uptrend.  With 2017's biggest pullback being just 2.9% so far it seems the S&P will experience a larger drop considering the average intra-year decline is 14%.

However, there remain many more bullish signals relative to bearish and that's why we remain optimistic overall.  The majority of major sectors and the big domestic stock indexes are firmly entrenched in longer term up trends and trade above their 50 and 200-day moving averages.  The S&P just finished its 5th straight positive month on a price return basis.  This has an upside statistical edge going out 1 to 6 months as the table below proves.  

And if we check in on the CNN fear and greed index it is showing that investor emotion currently sits in the fear range.  Meanwhile the latest NAAIM Exposure index reading is 77.04 down from the last quarter's average of 85.08. 

September has been, historically, a bad month with lots of volatility.  However, we remain believers that this is a secular bull and we'll be looking to put some of our cash to work as we near the end of this seasonally weak 3-month stretch and enter the usually strong 4th quarter.