Global equities are more than 15% higher than in February. A tailwind for this rally has been the bearish positioning of investors. Cash remains in favor (although levels dropped significantly this month) and equity allocations are just slightly higher than in February. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.
Bearish sentiment remains a tailwind for US equities. That is somewhat less true for European equities. Emerging markets became the consensus long last month and the region has since been pummeled. Those markets are now in the process of resetting.
Findings in the bond market are of greatest interest this month. Fund managers' inflation expectations have jumped to the highest level in 12-1/2 years. Similarly, their expectations that the yield curve will steepen are the highest in 3-1/4 years. When this has happened in the past, yields have been near a point of reversal lower, at least short-term.
The dollar is considered overvalued for the first time since April 2016. Under similar conditions, the dollar has fallen in value in the month(s) ahead.
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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.
Cash: Fund managers' cash levels dropped from 5.8% in October to 5% in November. That is a big drop for one month but recall that 5.8% was the highest cash level since November 2001. Cash has remained above 5% for all of 2016, the longest stretch of elevated cash in the survey's history. Some of the wind behind the rally has faded but cash remains supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish. Enlarge any image by clicking on it.
Global equities: Fund managers were just +5% overweight equities at their low in February; 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 November are only marginally higher, at +8% overweight. This is 0.8 standard deviations below the long term mean and supportive of further gains in equities in the month(s) ahead.
In February, 16% of fund managers expected a weaker economy in the next 12 months, the lowest since December 2011. Investors are still pessimistic, with only 35% expecting a stronger economy in the next year, but expectations are moving higher (the current month is the highest in a year). This explains the persistent low allocations to equities and high allocations to cash.
US equities: US exposure had been near an 8 year low during the past year and a half, during which US equities outperformed. US equities have been under-owned. After rising for two months this summer, allocations fell again to -7% underweight in both September and October. In November, fund managers were just +4% overweight. This is 0.4 standard deviations below its long term mean. Bearish sentiment remains a tailwind for US equities.
European equities: Fund managers had been excessively overweight European equities for more than a year in 2015-16, during which time EZ equities underperformed. That changed in July, with the region becoming underweighted for the first time in 3 years. That improved slightly to +5% overweight in both September and October and to +8% overweight in November. This is 0.3 standard deviations below its long term mean; it's now close to neutral. EZ equities have outperformed in the past 5 months since becoming underweighted.
Japanese equities: Allocations to Japan have been falling in 2016 as the region has underperformed. Allocations fell to -8% underweight in September, the lowest since December 2012, before rising slightly to -5% underweight in November. This is 0.4 standard deviations below its long term mean.
Emerging markets equities: As we said last month, "the contrarian long in emerging markets is over." A brief recap: in January, allocations to emerging markets fell to their second lowest in the survey's history (-33% underweight), an extreme comparable only to early-2014 from which the region began to strongly outperform. As the region outperformed the rest of the world again in 2016, allocations rose to +31% overweight in October, the highest in 3-1/2 years. That made the region the consensus long. Emerging equities have dropped sharply in the past month. Allocations are now +4% overweight. This is 0.6 standard deviations below its long term mean. The region is no longer the consensus long and probably in the process of resetting for the next push higher.
Global bonds: Fund managers are -48% underweight bonds, a fall from -35% in July (which was near a 3-1/2 year high allocation). This is neutral relative to the long term mean. Bonds outperformed in the 10 months before the current equity rally began in February, as allocations increased from -64% underweight in December (a 2-year low; green shading). They have since underperformed. Bonds are already out of favor but a capitulation low in the past has sometimes occurred when bonds were -60% underweight (red shading).
Of note, fund managers' inflation expectations have jumped to the highest level in 12-1/2 years. This explains some of the sell off in bonds in the past several months. It's notable that current levels have marked at least a short-term reversal point in yields in the past.
Similarly, in the past month, there was a massive increase in the percentage of fund managers who believe the yield curve will steepen in the next year. This is now at the highest level in 3-1/4 years. Similar cases, at either a high level or following a steep increase, have led to at least a short-term reversion lower in yields.
Commodities: Allocations to commodities rose to a 4-year high last month and remain there this month (-2% underweight). This is neutral relative to the long term mean. In comparison, in February, allocations were near one of the lowest levels in the survey's history (-29% underweight). The improvement in commodity allocations usually goes together with that for emerging market equities.
Sectors: Relative to history, managers are extremely overweight cash. They are more weighted towards bonds than equities. Overall, this is very defensive positioning.
Dollar: Since 2006, fund managers surveyed by BAML have been very good at determining when the dollar is overvalued. In March 2015, they viewed it as overvalued for the first time since 2009; the dollar index fell from 100 to 93 in the next two months. In late 2015, they again viewed the dollar as overvalued and the index lost 7%. This month, fund managers view the dollar as overvalued for the first time since April 2016, during which time the index has gained more than 7%. Under similar conditions (highlighted in green), the dollar has fallen in value in the month(s) ahead.
Survey parameters are below.
- Cash: 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.
- Equities: Over +50% is bearish. A washout low (bullish) is under +15%. More on this indicator here.
- Bonds: Global bonds started to underperform in mid-2010, 2011 and 2012 when they reached -20% underweight.
- Commodities: Higher commodity exposure goes in hand with improved sentiment towards EM.
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