Monday, February 22, 2021

Crash Imminent?

If you listen to the media they are always taking about the next crash. Based on their track record you have to take it with a grain of salt. Lets look at the actual data and make a more informed decision instead of chasing the next rumor. 

According to the latest BAML survey the only reason to bearish is there is no reason to be bearish. Essentially that means that sentiment is so positive everyone expects the market to continue higher. When fund managers are all positioned in the same direction it often is useful to be a contrarian and play devils advocate. Asking some simple questions and probing the consensus view can keep you from being sucked into the heard mentality. Lets look at the current BAML fund manager survey to see how bullish the current opinions are. 

BofA February Global FMS takeaways

Bottom line: the only reason to be bearish isthere is no reason to be bearish: FMS sentiment on global growth at all-time high, V-shaped recovery finally consensus, cash levels @ 8-year low, equity & commodity allocations highest since '11 (the last year both had negative returns), only 13% say it's a bubble BofA Bull & Bear Indicator @ 7.7.

Boom-boom: net 91% of investors say stronger economy in 2021, majority now say it's a V-shaped recovery, 1st time since Jan'20 investors want CIO's to "increase capex" rather than "improve balance sheet"; CPI, EPS & yield curve expectations close to record highs.

Cash is trash: FMS cash level down to 3.8%, lowest since Mar'13 (just before Bernanke "taper tantrum"); allocation to stocks & commodities highest since Feb'11; record number investors taking "higher-than-normal" risk.

Risks & crowds: investors view top "tail risks" as vaccine rollout (28%...timing of positive impact has slipped to July), taper tantrum (25%), inflation (24%); "crowded trades" are long tech (35%), long Bitcoin (27%), short dollar (13%).

Cyclical vs tactical: FMS shows cyclical consensus is "cyclical"high exposure to commodities, EM, industrials, banks relative to past 10 years; but Jan wobble caused investors to top-up "safety of growth" exposure via tech, health care, US stocks.

Anti-Goldilocks contrarian trades: bubble move and/or big inflation in 2021 best played via FMS laggards e.g. energy & UK stocks; conversely longs in EM, commodities, industrials most vulnerable to "peak profits" narrative; either way consumer staples a smart contrarian accumulator in H1.

 

FMS cash drops to 3.8% from 3.9%, remaining a FMS Cash Rule "sell signal" (back tested 1-month S&P 500 return = -3.2%).


All-time high in investors taking "higher-than-normal" risk now at 25% in February.

FMS investor optimism on cyclical risk assets increases to net 87%, 2nd highest ever (#1 = Feb'11 - last year equity & commodity returns negative). Fund managers are heavily long while expecting inflation to pick up. 

The most recent AAII sentiment survey shows optimism rising to a nine-week high as bullish sentiment is well above its historical average of 38% for the 12th week out of the past 14 weeks. 
 
Based on the current valuation the markets subsequent 1-year returns don't look favorable. But with interest rates artificially low does this change the narrative?  


According to JP Morgan the average intra-year decline is 14% so this is expected.

Yet the market is just coming off a bear market low.

Ryan Detrick highlights how this new bull stacks up against the previous two best starts to a bull market ever ('82 and '09). This one continues to break records, but still be aware the previous two were choppy the next several months.

The chart below is a weekly chart of the Nasdaq and the lower panel is the % above or below the 40 week moving average. Historically, the Nasdaq is extended to the upside. Yet if we look at other times we have hit these levels it has more in common with the earlier stages of a bull market rather than the end. One bit of caution, most of these bull market runs have run into resistance eventually after hitting extremes and experience a deeper pullback. If we look at the 1992, 2004, and 2010 time frames it will give us an idea of what we might expect. The Nasdaq peaked roughly 10 months after the 1991 signal, 4 months after the 2003, and 7 months after the 2009 signal. Each of those periods saw a draw down of: 1991 (-15.5%), 2004 (-18.7%), 2010 (-18.7%).

Below is the ratio chart of high beta vs low volatility. When this chart is going up high beta is leading the market. Until this rolls over expect most pullbacks to be shallow and short.


In summary, sentiment is definitely stretched to the upside and most fund managers are bullish. Alone this isn't bearish but leaves me more cautious in the short term. We should expect a pullback at some point but we expect that pullback to be short, shallow, and bought. The breadth readings are more characteristic of early bull market phases rather than tops and why we don't see this market crashing. However, based on precedent we should see a bigger correction (10%+) further down the road much like 1992, 2004, and 2010. As always we'll continue to stay flexible and nimble and when conditions change we'll be ready to act.


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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