Tuesday, December 15, 2015

Fund Managers' Current Asset Allocation - December

Summary: Fund managers' asset allocations in September and October indicated the most bearishness since 2012. It was a strong contrarian bullish set up for equities, especially in the US, and equities rallied (post).

Fund managers' cash in December remains high. This is bullish.

Global allocations to equities are near 7-month highs.  However, this is mostly due to Europe and Japan. Allocations to Europe are the fourth highest ever, conditions under which the region would usually underperform.  Allocations to Japan also jumped higher this month.

Allocations to the US dropped to an 8 year low, a level from which the US should continue to outperform as it has the past 8 months. Emerging markets continue to be very underweighted.

The dollar is considered to be the second most overvalued in the past 7 years. Under similar conditions, the dollar has fallen in value.

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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).

In September, fund managers held 6-year high levels of cash and 3-year low levels of equities: a strong contrarian buy signal. Since then, SPX is up 7% (post).

Let's review the highlights from the past month.

Fund managers cash levels jumped back up to 5.2%; it's been over 5% five of the past six months, the first time it had been this high for this long since late-2008 and early-2009. This is an extreme that is normally very bullish for equities.

Fund managers are +42% overweight equities, near a 7-month high. Given the rise in equities since August, current levels are not surprising.  Over 50% would be considered contrarian bearish (green line). Global equity allocations are neutral.

US exposure dropped dramatically to -19% underweight in December, an 8 year low. Despite low exposure, US equities have outperformed the past 8 months. US equities have been under-owned and should continue to outperform those in Europe and Japan on a relative basis (see below).

Eurozone exposure is the fourth highest ever, at +54% overweight. This is 1.5 standard deviations above the long term mean. Judging from 2006, European equities are at risk of underperforming.

Allocations to Japan increased to +37% overweight, 1.2 standard deviations above the long term mean.  In the 10 months prior to September, allocations were the highest since April 2006.

Emerging markets exposure increased slightly (-27% underweight) from the 3rd lowest ever in November.  Fund managers have been right to underweight this region, but current allocations are an extreme comparable only to early 2014, from which the region began to strongly outperform for the next half a year.

Fund managers are -64% underweight bonds, a new 2-year low. Bonds continue to be the most underweighted asset class and this, in large part, explains why cash balances have not been lower than 4.5% in two years. Note that bonds have outperformed in the past 8 months.

The drop in allocations to bonds comes as fund managers have become more optimistic about the global economy. At the recent bottom in equities, macro optimism was at a 3-year low. Now, only 7% expect a recession in the next 12 months.

Allocations to commodities fell to a 3-month low of -29% underweight. This is 1.6 standard deviations below the long term mean. The low allocation to commodities goes together with pessimism towards emerging markets and also explains why cash balances are high.

Managers remain overweight the highest beta equities (discretionary, banks). The largest underweights are in commodities (including energy and materials) and defensives, like staples. Technology is still overweight, but allocations fell hard in the past month.

Fund managers' allocation to banks is among the largest ever1.7 standard deviations above the mean. It's a small sample, but banks have underperformed in the past when this overweight.

Fund managers' allocation to technology was the second largest ever last month, but dropped in December (to 0.6 standard deviations above the mean).  Tech underperformed in mid-2010 when it was as overweight as it was in November. The current drop in exposure looks similar to 2014 before the sector started to briefly underperform.

Since 2006, fund managers surveyed by BAML has been very good at determining when the dollar is overvalued. In March, they viewed it as overvalued for the first since 2009; the dollar index fell from 100 to 93 in the next two months. They again view the dollar as overvalued (second highest in 7 years) and the index has recently turned lower. Similar cases are highlighted in green.

In summary: Fund managers are overweight cash and this is a tailwind for equities. The US and EM equities remain very underweight relative to Europe and Japan.  If fund managers are again right about the dollar, it might continue to turn lower.

Survey details are below.
  1. Cash (5.2%): Cash balances increased to 5.2% from 4.9%. July and September (5.5%) were the highest cash levels since December 2008. Typical range is 3.5-5%. BAML has a 4.5% contrarian buy level but we consider over 5% to be a better signal. More on this indicator here
  2. Equities (+42%): A net +42% are overweight global equities, up from a contrarian bullish +17% in September and +26% in October. Over +50% is bearish. A washout low (bullish) would be under +15-20%. More on this indicator here
  3. Regions
    1. US (-19%): Exposure to the US fell hard from -6% to -19% underweight. This is an 8 year low.  
    2. Europe (+55%): Exposure to Europe fell slightly to +55% overweight (4th highest ever) from +58% overweight in November. 
    3. Japan (+37%): Exposure to Japan increased to +37% overweight from +28% in November. Funds were -20% underweight in December 2012 when the Japanese rally began. 
    4. EM (-27%): Exposure to EM increased to -27% underweight from -31% underweight in November (3rd lowest ever).  It was -34% underweight in September, the lowest in the survey's history. 
  4. Bonds (-64%): A net -64% are underweight bonds, a fall from -41% in October. For comparison, they were -38% underweight in May 2013 before the large fall in bond prices. 
  5. Commodities (-29%):  A net -29% are underweight commodities, a drop from -23% last month. Low commodity exposure goes in hand with low sentiment towards EM.
  6. Macro: About 30% expect a stronger global economy over the next 12 months, a big drop from over 60% earlier in 2015.  

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