When Is Fund Manager Equity Exposure Extreme?

This is a follow on to the prior post on fund manager cash balance data from the monthly BAML report. This time, we are looking at equity exposure. The charts are from the same article by Short Side of Long found here.

Like cash balance, there is a good signal when investors feel panic near market bottoms. Below 10-15% equity weighting and I will be looking long. Even in early 2008, there was a sizable bounce before heading lower. There were other reasons to ignore this signal later that year.

When Is Fund Manager Cash Balance Extreme?

BAML publishes a monthly report on fund managers' cash balances. On the Weekly Market Summary, you will see that we look for extremes above 5% (bullish) and below 3.5% (bearish). 

Below are two charts from 2001-2012 from Short Side of Long. This excellent article on this subject is here. 

In the first, the lines are for cash above 5%. The most recent signal was at the June 2012 low. Even in 2008-09, this turned out to be a very useful indicator of extreme panic. A Fat Pitch.

Buy When the VIX is High (Above 40)

Having just shown that the best risk/reward is when the VIX is below 20, you'll find a surprisingly good bounce in $SPX when VIX spikes above 40. In the chart below, from 1996 to 2012, there were 5 great buying opportunities when VIX over 40. Unfortunately, buyers using this strategy were destroyed  in 2008. So there you go: it works 83% of the time.

A great chart from Short Side of Long below:

Best $SPX Risk/Reward When VIX is Under 20

The best risk/reward in $SPX occurs when VIX is under 20. Average monthly returns (1.5%) and the maximum downside (-4.4%) occur during these periods. On average, monthly returns are positive 77% of the time. 

For comparison, when VIX is 25-30, average monthly returns drop (0.2%), maximum downside doubles (-9.1%) and the monthly returns are positive only 52% of the time. 

It gets worse the higher the VIX. A nice report can be found here with a the summary table extracted below.

McClellan: 40 Year Cycle in DJIA

A chart from Tom McClellan showing the DJIA 40 year cycle. Each point on the chart is compared to the period 40 years prior. According to this cycle, a big bottom is coming up in 2014 following a big top this year.

Sentiment Expressed in the Press

Sentiment expressed in the press is always gloomy at market bottoms. Here are two examples. The first is from December 2011. "Our decade from hell will get worse in 2012." $SPX rose over 20% in the next 12 months.

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What is the Fat Pitch?

In baseball, a fat pitch is a hittable ball. The odds are in your favor. You might miss, but it is a situation where you should take a swing of the bat. If you swing at good pitches and avoid the crappy ones, you improve your OBP. Once on base, it become a running game.

The stock market serves a lot of curve balls. Now and then comes a Fat Pitch, your odds-on opportunity to swing the bat. Get on base and then manage your base-runners.

Specifically, the Fat Pitch on this site refers to two situations.

Fat Pitch Market Summary: A Structured, Quantitative and Empirical Methodology

The objective of the Fat Pitch is to provide a structured, quantitative and empirical methodology for evaluating the state of the market. At any point in time, there are a variety of factors pulling on the market. We want to determine the relative importance of each factor in order to answer two questions:

1. In which direction should we be investing in the market? 
2. Are tailwinds behind this direction or are headwinds picking up?

Every Friday we publish a Weekly Market Summary with green, yellow and red lights on it. Green is good and red is bad. Everything on this site is in support of this market summary. The little tabs across the top of the site (trend, breadth, etc) mirror the different factors we follow to monitor the market. There is nothing here that doesn't fit with the methodology. Anytime you want to understand why a factor is red or green, click on the tab and read the accompanying analyses. To the fullest extent possible, we quantify and use empirics to determine the state of every factor.

Each factor discussed below.

Who is the author of this blog?

Everyone always wants to know how the story ends. So let's start there.

2013
Started this blog.

2010
Blocked by Zero Hedge.

2008
SPX at 1500. Said, "I will now spend more time trading." Learned many real time lessons.

1998
Moved back the US and founded consulting firm with two partners. Continues at present. Focus is on corporate and product strategy, especially for medical technology companies. Many large, listed companies are clients.

For Entertainment and Educational Purposes Only

Nothing here constitutes advice. All investment decisions you make are your own.