Wednesday, January 17, 2018

Plenty of bulls

The dominant trend of global equities remains higher and has accelerated to the upside to begin the year.   A handful of indicators are flashing frothy levels in the short term but the first few weeks of the New Year also ushered in an increase in breadth as momentum accompanied new price highs.  Today's reversal after the large gap up could signal that we are due for some weakness in the near future.  The data and sentiment suggest that we are overdue for some give back after the torrid pace set in the first few trading weeks of the year.  In the first two charts below we look at how breadth has expanded in the form of new 52-week highs and the % of stocks trading above their 50 & 200 day moving averages.  Both indicators are expanding as the indexes make new highs.  The last chart shows how the S&P remains overbought based on the 14 period RSI.  If we look at examples from last year's bull run, when the RSI reached extremes, the market tended to consolidate once it reach these levels.  Steve Deppe sums up what the data looks like after yesterday's one-day outside reversal from 52-week highs while volatility is also rallying.  


Sentiment and position presented in the monthly BAML survey gives us a glimpse into fund managers perspective on the global investing landscape.  The viewpoints documented in the monthly survey gives us the ability to look at a potential contrarian outlook to shape trades against the herd.  January's data has plenty of trends to observe and below we address the more notable takeaways. 

January rotation shows a buying of cyclical plays and selling of defensive plays.

Net hedge fund equity market exposure jumps to 49% which is the highest since 2006.

A majority of investors now expect a peak in equity markets in 2019 or beyond, pushing back the timing by two quarters from December, when the majority expected a top in Q2 2018.

Investors overweight allocation to equities relative to overweight bonds highest since August 2014.

Allocation to equities jumped to 2-year highs of net 55% overweight.  Current allocation is high at 1.1 stdev above its long-term average.

Allocation to US equities slips to net 17% underweight from net 15% underweight last month while allocation to Eurozone equities holds a net 45% overweight remaining elevated vs history. 

In conclusion, the trend remains up as all US equity indices hit a new high yesterday.  However, with the reversal off new highs on healthy volume after the current thrust higher over the last week, we expect volatility to pick up.  Coupled with the excessive sentiment and the aggressive positioning in equities from managers we are watchful for any pending weakness.   From a contrarian trade it seems as the herd is positioned for continued strength with little worry of the market peaking.  Considering how fund managers are deploying their capital the biggest shock would be a market top in the first quarter and a real correction during 2018.  We still believe the market is healthy and short term pullbacks should be expected.  We view these potential pullbacks as opportunities and still favor US equities as they remain underweight versus their European counterparts. 

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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