Fund Managers' Current Asset Allocation - July

Summary: Global equities have risen 7% in the past 3 months and 16% 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 nearly their lowest level since November 2008 in July: this is when US equities usually outperform. In contrast, weightings towards Europe in particular have jumped to levels that suggest this region is likely to underperform. These weightings also suggest that Europe is likely to be the source for any global "risk off' event. Notably, the S&P has outperformed the Europe's STOXX600 by 7% the past two months.

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 eight months, fund managers are neutral towards the dollar after having considered it overvalued since November.  During this time, the dollar has fallen 7%. A headwind to dollar appreciation has dissipated.

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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 very 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. 

Weekly Market Summary

Summary:  US equities reached a new one-month low late last week before rebounding on Friday. In particular, NDX found support right on its mid-May low. This is now an important line in the sand, with implications for SPY as well; so long as the Thursday low holds, look for higher prices.

Despite general weakness in equites over the past several weeks, there have been no notable extremes in breadth, the volatility term structure or put/call ratios that often mark durable lows. On balance, this suggests any short-term gains are unlikely to be sustained longer-term. Moreover, in the past 2 weeks, equities have posted strong gains overnight that have been entirely given up during cash hours, a pattern that has the whiff of distribution.

Earnings reports for 2Q begin this week.

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US equities remain in a long term uptrend. The 20-weekly ma (blue line) is often an approximate level of support during uptrends. Enlarge any image by clicking on it.

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July Macro Update: Recession Risk Remains Low

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  SPX has gained every month in the first half of the year, and it is up 8 months in a row for just the fifth time in 26 years. Long streaks like these have consistently led to further gains in the following months. Likewise, strong gains to start the year - SPX gained 8% in the first half and NDX gained 16% - have most often led to further gains in the second half of the year. The bullish trend in equities is supported by continued advances in the macro economic data.

The crack that opened in NDX two weeks ago has widened further. The index has now fallen 5% and has broken below its 50-dma. The consistent historical pattern is for SPX to follow, lower. That hypothesis is further supported by bullish sentiment - at a 3-1/2 year high by at least one measure - and the exceedingly tight trading range in SPX over the past month which most often precedes an expansion in volatility.

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For the week, large cap stocks lost 0.5% while the Nasdaq-100 (NDX) lost nearly 3%. The volatility index, VIX, gained 11%.

Equities have finished a very strong first half of the year. US large caps gained +8% while NDX gained twice that (+16%). Both of these outperformed the consensus long, Europe (+5%). But the best performing region to start the year was emerging markets, which gained an astounding +18%. Enlarge any chart by clicking on it.