by Urban Carmel, The Fat Pitch
Summary: Global equities have risen 5% in the past 3 months and nearly 20% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering doubts and fears. They have become more bullish towards equities, but not excessively so: less than half expect better profits and a better economy in the next 12 months.
Allocations to US equities dropped to their lowest level in 9 years in April and remain nearly this low in June: this is when US equities typically start to outperform. In contrast, weighting towards Europe and emerging markets have jumped to levels that suggest these regions are likely to underperform.
Fund managers remain stubbornly underweight global bonds. Current allocations have often marked a point where yields turn lower and bonds outperform equities.
For the first time in seven months, the dollar is no longer considered highly overvalued. Since November, the dollar has fallen 4%. A headwind to dollar appreciation has dissipated.
* * *
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, managers are overweight equities and cash and very underweight bonds. 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.
Cash: Cash rose to 5.0% in June. This is still supportive of further gains in equities. A recap:
Fund managers' cash levels rose to 5.8% in October 2016, the highest cash level since November 2001.
Cash remained above 5% for almost all of 2016, the longest stretch of elevated cash in the survey's history.
At current levels (5.0%), some of the tailwind behind the rally is now gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish.
Global equities: Despite a 16 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 June have increased to +40% overweight, which is only slightly above neutral (0.5 standard deviations above the long term mean). There is room further equity gains.
Outside of 2013-14, over +50% overweight has historically been bearish (dashed line and shading).
In February 2016, more than 20% of fund managers believed profits would be
weaker
in the next 12 months, the lowest since 2012. They are now more optimistic, but not exceptionally so: 43% expect
stronger
profits in the next year. Pessimism explained their prior low allocation to equities and high allocation to cash; that has now changed a bit.
Similarly, many (but less than half; 39%) expect a better economy in the next year. This also explains their generally improved enthusiasm for equities.
US equities: US equities are out of favor and should outperform. A recap:
Fund managers were consistently and considerably underweight US equities for a year and a half starting in early 2015, during which US equities outperformed.
That changed in December 2016, with fund managers becoming +13% overweight, and they remained overweight through February: bearish sentiment was no longer a tailwind for US equities and US equities underperformed their global peers.
Fund managers have now dramatically dropped their allocation to -15% underweight, near the lowest since January 2008 (0.6 standard deviations below its long term mean). This is where US equities typically start to outperform again.
Above +20% overweight and sentiment typically becomes a strong headwind (dashed line).
European equities: European equities are at high risk of underperforming. A recap:
Fund managers had been excessively overweight European equities in 2015-16, during which time European equities underperformed.
That changed in July 2016, with the region becoming underweighted for the first time in 3 years. The region then began to outperform.
European exposure jumped to +58% overweight in June, near a 26-month high. This is well above neutral (1.7 standard deviations above its long term mean). European equities are at high risk of underperforming.
Fund managers' positioning in Eurozone equities versus the rest of the world is highest since January 2016, after which the region began to underperform.
Emerging markets equities: Emerging market equities are at risk of underperforming. A recap:
In January 2016, allocations to emerging markets fell to their second lowest in the survey's history (-33% underweight).
As the region outperformed in 2016, allocations rose to +31% overweight in October, the highest in 3-1/2 years. That made the region a contrarian short: emerging equities then dropped 10% in the next two months.
Allocations fell to -6% underweight in January 2017, making the region a contrarian long again: the region has since outperformed.
This month, allocations jumped to +42% overweight, near a 5-year high (1.0 standard deviations above its long term mean). Emerging market equities are at risk of underperforming.
Global bonds: Bonds are a contrarian long. A recap:
In July 2016, global bond allocations rose to -35% underweight, nearly a 3-1/2 year high. Bonds have since underperformed a 60-30-10 basket.
In June, fund managers are -58% underweight bonds. This is 0.8 standard deviations below its long term mean and among the lowest weightings in the past 3 years.
A capitulation low in the past has often occurred when bonds were -60% underweight, a level reached in March and April (shading and dashed line). In other words, bonds are now a contrarian long.
Note the failure in 2013.
Of note, fund managers' inflation expectations in March were at the highest level in 13 years; June was only slightly lower (60%). Recent levels marked at least a short-term reversal point in yields in the past, as they have this time as well (lower panel).
Similarly, fund managers' growth expectations relative to inflation were recently near the highest level on record; a similar high in 1Q 2010 preceded a fall in yields, as it has this time as well (arrows).
Commodities: Allocations to commodities dropped to a 1-year low in June (-15% underweight). This is 0.7 standard deviations above its long term mean. Despite improving macro optimism, commodities remain out of favor, although not at an extreme.
Dollar: The headwind to the USD has now dissipated. A recap:
Since 2004, fund managers surveyed by BAML have been very good at determining when the dollar is overvalued (highlighted in green).
In March 2015, they viewed it as overvalued for the first time since 2009; the dollar index fell from 7% in the next two months.
In late 2015, they again viewed the dollar as overvalued and the index lost 7%.
Fund managers have viewed the dollar as overvalued since November 2016; since then, the dollar has lost about 4%.
In June, only 7% view the dollar as overvalued. The overvaluation headwind has now dissipated.
Survey parameters are below.
- Cash: The typical range is 3.5-5.0%. BAML has a 4.5% contrarian buy level but we consider over 5% to be a better signal. More on this indicator here.
- Equities: Over +50% overweight is bearish. A washout low (bullish) is under +15% overweight. More on this indicator here.
- Bonds: Global bonds started to underperform in mid-2010, 2011 and 2012 when they reached -20% underweight. -60% underweight is often a bearish extreme.
- Commodities: Higher commodity exposure goes in hand with improved sentiment towards global macro and especially EM equities.
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