Interview With Financial Sense on What To Look For Ahead of an Equity Market Peak

We were interviewed by Cris Sheridan of Financial Sense on March 13th. During the interview we discuss the macro-economic environment, the housing market, current market technicals and the financial performance of US companies. One theme of our discussion is what to look for ahead of the next bear market in US equities. Another theme is a potentially bullish set up for US treasuries over the next several months.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

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Fund Managers' Current Asset Allocation - March

Summary: Fund managers came into 2018 very bullish equities. Cash levels had fallen to the lowest level in 4 years. Allocations to global equities had risen to the highest level in nearly 3 years. Bond allocations were at a 4 year low. Our view at the time was that "this is a headwind to further gains" in equities. That post is here.

Since then, global equity allocations have fallen and cash balances have risen. Investors are no longer at a bullish extreme, but the equity shakeout certainly did not make them fearful.

In the past 8 months, US equities have outperformed Europe by 13% and the rest the world by 5%. Despite this, fund managers remain underweight the US. US equities should outperform their global peers on a relative basis.

Fund managers remain underweight global bonds by the greatest extent in 4 years. US 10 year treasuries have outperformed US equities (NYSE) by nearly 400bp in the past two months.

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Among the various ways of measuring investor sentiment, the Bank of America Merrill Lynch (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. Our sincere gratitude to BAML for the use of this data.

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 overweight equities and cash and underweight bonds. Enlarge any image by clicking on it.

Within equities, the US is significantly underweight while Europe, Japan and emerging markets are all significantly overweight. 

A pure contrarian would overweight US equities relative to Europe, Japan and emerging markets, and overweight global bonds relative to a 60-30-10 basket. 

Weekly Market Summary

Summary:  The Nasdaq closed at a new all-time high (ATH) on Friday. It has risen 6 days in a row. A number of studies suggest that it should continue to rise further, and that SPX should follow it, probably also to a new ATH. That is the near term set up as equities enter March options expiration week.

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Last Friday's 2% intraday turnaround continued this past week. US equities gained 4% (from Alphatrends). Enlarge any chart by clicking on it.

March Macro Update: Nine Years Into the Recovery, 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 likely last through 2018 at a minimum. Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  The long term trend in US equities remains firmly higher. Expectations should be for equities to rise in the months ahead. The near term directional edge is more muted. Worldwide, equities are in the process of retesting their February lows. The US is being held up mostly by technology and financial stocks. Whether the US follows the rest of the world lower is largely dependent on politics: specifically, whether trade war rhetoric evolves from saber rattling to reality. March and the upcoming OpX week are a strong seasonal tailwind.

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After falling 12% from their January high, and then bouncing 10% from their February low, equities fell 5% during the past week. A 2% turnaround on Friday eased some of the losses, with SPX closing down 2% for the week (from Alphatrends). Enlarge any chart by clicking on it.