by Urban Carmel, The Fat Pitch
Summary: Global equities have risen 12% in the past 6 months and 17% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering risk aversion. They have become more bullish towards equities, but not excessively so with their hedging activity near a 10 month high.
Allocations to US equities dropped to their lowest level in 10 years (since November 2007) in September: this is when US equities usually outperform. In contrast, weightings towards Europe and emerging markets have jumped to levels that suggest these regions are likely to underperform on a relative basis. These weightings also suggest that Europe and/or emerging markets are likely to be the source for any global "risk off' event. Notably, the S&P has outperformed Europe's STOXX600 by 10% the past four months.
Fund managers are modestly underweight global bonds.
The US dollar has gone from overvalued a few months ago to the most undervalued in nearly 3 years. Fund managers had viewed the dollar as overvalued starting in November 2016; since then, the dollar has lost about 8%. Contrarians should be alert to a change in direction for the dollar.
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Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.
The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).
Let's review the highlights from the past month.
Overall: Relative to history, fund managers are very overweight cash and underweight bonds. Their equity allocation is modestly overweight. Enlarge any image by clicking on it.
Within equities, the US is significantly underweight while Europe is significantly overweight.
A pure contrarian would overweight US equities relative to Europe and emerging markets, and overweight global bonds relative to a 60-30-10 basket.
Fund managers' cash levels rose to 5.8% in October 2016, the highest cash level since November 2001. This set up a contrarian long in equities.
Cash remained above 5% for almost all of 2016, the longest stretch of elevated cash in the survey's history.
At current levels (4.8%), some of the tailwind behind the rally is gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month(s) ahead, however, would be bearish.
Similarly, a composite measure of risk (based on allocations to cash, higher risk assets and investment horizon) is only neutral despite the long rally in equities. This also supports further gains in equities.
Global equities: Despite a 19 month rally, equity allocations are only slightly above neutral. There is room for further gains. A recap:
Fund managers were just +5% overweight equities at their low in February 2016; since 2009, allocations had only been lower in mid-2011 and mid-2012, periods which were notable bottoms for equity prices during this bull market.
Allocations in September have increased to +34% overweight, which is only slightly above neutral (0.2 standard deviations above the long term mean).
Outside of 2013-14, over +50% overweight has historically been bearish (dashed line and shading).
Similarly, only a net 27% of fund managers have not bought equities hedges (i.e., downside protection). Current levels are similar to those prevailing prior to the US election last autumn. This further indicates a lack of complacency.