Interview with Financial Sense on Running for Political Office and the Macro Outlook for 2020

I was interviewed by Cris Sheridan of Financial Sense on December 17th.

This was a two-part interview; in the first half, I discuss my current run for political office and the challenges facing small cities; in the second half, I discuss the macro and equity outlook for 2020. If you want to skip around, here are some guideposts:

• 2 minute mark: my reasons for running for political office
• 11 minute mark: the challenges facing small towns like ours in the next decade
• 24 minute mark: the US macro outlook for 2020, with a focus on housing and other leading indicators
• 32 minute mark: what macro and things like investor sentiment mean for the stock market in the coming year

My 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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Some Personal News

Update from March 4, 2020:

We won!

__________________

Original post on November 22, 2019:

I live in a town across the Golden Gate Bridge called Mill Valley. My wife and I moved here in 1999 with our two small children who were 4 and 1 years old at the time. It was near the end of the dot.com bubble. We were both consultants living in Silicon Valley and experienced this period up close.

I told my wife that I thought we were buying our house at the top of the market. She turned to me and said: "We are not buying a house, we are buying a home. This is where we raise our children. This is where we make our life."

As usual, she was right. I coached Little League and soccer for 10 years. My kids both ran the Dipsea Race every year. My son became an Eagle Scout. We all volunteered for our local library. Both kids started kindergarten here and graduated from the local high school, all public. They've now moved away. They're adults.

Outside of work and writing The Fat Pitch, I have run a 501(c) benefiting our library and chaired our town's Planning Commission. We love this town, we want to make it the best it can be, we will never leave. We believe in action, not words. We don't just talk, we do.

In September, I wrote a piece on the US economy and then went on a trip overseas for the rest of the month. When I returned, I started a campaign to run for elected office on our town's City Council. I met with every living former mayor, explained who I was and what I wanted to accomplish, and was endorsed by all, 19 in total. I am doing the same with as many other community leaders as I can and if they are in a position to endorse a candidate, then they have endorsed me. I am extremely grateful and humbled by everyone's support and encouragement. This feels right. I'm excited.

This has been time consuming, but I can't think of anything more important. I sat with an owner of a vital and iconic shop in downtown Mill Valley this week, a person raised here, retired here and who has over the past several decades met with every future mayor. He grilled me on housing, finances, traffic, human resources and every other topic of importance. 90 minutes went by like it was 5. It was thrilling, and I once again learned many things I didn't know the day before.

I have never run for public office. I never thought this is where life would lead me. I'm 56 years old, I have lived here for 20 years, I have been deeply involved in my community and I feel like I can make a difference. I don't have an answer for everything, there's a lot I don't know, but I will listen, I will ask questions, I will study, I will act with integrity and honesty, I will give this my every effort and I will try to do the right thing.

I have put a lot of effort into writing The Fat Pitch. I have wanted it to be the best source of financial and economic analysis that I could create. I wanted to help anyone willing to read it to learn and question and think and hopefully improve. It did all of those things for me. I don't believe in half measures, so I haven't written in a while. When I can commit the needed time, I will start writing again. I miss it, I'm committed to it and I will return to it.

If you are reading this and happen to live in Mill Valley, please get in touch. If you know someone here, spread the word. I am trying to run a different type of campaign, one where thousands of mailers and hundreds of lawn signs are replaced by email, phone calls, meetings at coffee shops and by my feet walking in neighborhoods.  I want every voter to have met me, read about me or to have heard about me from a trusted friend. I don't want a vote based on a lawn sign or a piece of mail. That is all landfill. The recent fires and power shutdown in California are a timely reminder that we need to change the way we do things, and it starts with something as simple as a local election. It starts now.

You can read more here: https://urbancarmel.com/

September Macro Update: Rising Possibility of a Recession in 2020

Summary: The balance of the macro data remains positive. A recession starting in 2019 is unlikely, but, for the first time, a recession in 2020 is a rising possibility.

The bond market sees weakening growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (dots). The lag between inversion and the start of the next recession has been long: at least 7 months and in several instances as long as 2-3 years. Notably, the yield curve finally inverted in August; on this basis, the current expansion will likely last through 2019 but 2020 is now at risk (from JPM). Enlarge any image by clicking on it.

2Q Corporate Results: 2% Earnings Growth Expected in 2019

Summary: Overall, corporate results in the second quarter of 2019 were fine, but growth has slowed. Sales and earnings were up were 5% and 4% yoy, respectively. Margins rebounded from the end of 2018 but are still below the cycle high made in 3Q18.

Looking ahead, analysts' expectations for 10% earnings growth in 2019 have been revised down to just 2%. This estimate will be about right if margins can be maintained at the current level and the dollar doesn't further appreciate, but another drop in oil prices could cause earnings growth to decline towards zero.

For 2020, analysts currently expect growth of 5% to sales and 11% to earnings. This is too optimistic. Assuming no change in the dollar, oil and margins, earnings growth is likely to be halved. Margin compression (likely) would lower growth much more.

Valuations are now back to their 25-year average. They are not cheap, but if investors once again become ebullient, there is room for valuations to expand. With earnings growth likely to be negligible, the key for share price appreciation in 2019 (and 2020) is likely to hinge almost entirely on valuations expanding.

* * *

93% of the companies in the S&P 500 have released their second quarter (2Q19) financial reports. The headline numbers were fine, but growth has slowed. Here are the details:


Sales

Quarterly sales grew 5% over the past year, to a new all-time high (ATH). On a trailing 12-month basis (TTM), sales were 7% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.

August Macro Update: Housing Weak But Recession Unlikely In 2019

Summary: The 25bp rate cut by the FOMC this week was warranted given ongoing weakness in housing, but the balance of the macro data remains positive, meaning a recession starting in 2019 is unlikely.

The bond market sees continued but modest growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (dots). The lag between inversion and the start of the next recession has been long: at least 7 months and in several instances as long as 2-3 years. The yield curve has not yet inverted; on this basis, the current expansion will likely to last through 2019 at a minimum (from JPM). Enlarge any image by clicking on it.

High Consumer Confidence Is A Notable Stock Market Warning

Summary:  In July, the Consumer Confidence Index (CCI) jumped to its highest level since last September, right before stocks started a 20% correction. Sometimes a high in the CCI coincides closely with a 5% or greater fall in stocks, but at other times the lag has been many months. In general, however, the risk/reward for investors over the next 6 months has not be favorable.

* * *

In July, the Conference Board's Consumer Confidence Index (CCI) jumped to the highest level since last September. According to the Conference Board: “Consumers are once again optimistic about current and prospective business and labor market conditions. In addition, their expectations regarding their financial outlook also improved."

The CCI was created in 1967, based on a monthly survey of 5,000 households. The report gives details about consumer attitudes (how would you rate the current business and employment situation; do you think your income will be higher or lower in 6 months) and buying intentions.

Increasing confidence is generally good for the economy as it drives consumption, which is 70% of the US economy.

But excessive confidence is not good, especially for the stock market. The timing is far from perfect but risk/reward and forward returns are often poor.

The current CCI is now 136. It has been higher in only 3 other periods: the late 1960s, the late 1990s and last year (the next 4 charts are from Sentimentrader; to become a subscriber and support the Fat Pitch, click here). Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  The broadest US equity indices made new all-time highs last week. Stocks have risen 6 of the past 7 months and by more than 20%. The summer months can see interim weakness, but this level of momentum has a strong propensity to carry stocks higher into year-end.

The FOMC is likely to lower its guidance rate tomorrow. When the economy is expanding and stocks are near their highs (like now), this has been a net positive for equities.

Sentiment data is inconclusive, but a 3-5% decline wouldn't be unusual at this point, especially as the typically weak August-October period is now here.

* * *

The rally since early June has carried SPX more than 10% higher in just two months. July will likely end with US equities higher for the 6th time in the past 7 months (table from alphatrends.net). Enlarge any chart by clicking on it.

July Macro Update: Housing Remains The Weakest Link

Summary: A small "insurance" rate cut by the FOMC later this month appears warranted given ongoing weakness in housing, but the balance of the macro data remains positive, meaning a recession starting in 2019 is unlikely.

The bond market sees continued but modest growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (dots). The lag between inversion and the start of the next recession has been long: at least 7 months and in several instances as long as 2-3 years. The yield curve has not yet inverted; on this basis, the current expansion will likely to last through 2019 at a minimum (from JPM). Enlarge any image by clicking on it.

Small Caps Are Lagging. Investors Should Be More Concerned When They Lead

Summary:  SPX made a new all-time high (ATH) last week. DJIA and NDX were not far behind. And the broadest measure of the US stock market comprising 98% of stocks came just 0.1% shy of a new ATH.

By contrast, small caps are lagging. They have retained none of their gains made over the past 1-1/2 years and haven't been close to a new ATH in 10 months. Should investors be worried?

By most measures, the answer is probably not. Small cap underperformance has more often marked a low in SPX, not a high. Investors should be more worried when small caps - which are highly speculative and high beta - lead, as this has most often been a feature of major bull market tops, the reverse of the situation we have now.

* * *

Last week, SPX made a new all-time high (ATH). The DJIA equalled its ATH from October 2018 and NDX came within 1% of its ATH from just last month. The broadest measure of the US stock market, the Russell 3000, which comprises 98% of stocks, exceeded its May high and came within 0.1% of its October 2018 ATH. By most measures, US stock prices are doing well. Enlarge any chart by clicking on it.

An Extreme In Investor Fear And Pessimism

Summary:  Fund flows out of equities and into the safety of bonds is the most extreme in more than 15 years. Retail investor bearishness is consistent with that at Christmas, early 2016 and other durable lows in equities.

Fund managers surveyed by BAML are similarly pessimistic. Their cash allocation is one of the highest in 16 years. Their equity allocation is the lowest since the bear market bottom in March 2009. And their allocation to bonds is near an 8-year high.

All of this suggests a continued upside tailwind for equities and a strong headwind for bonds. Could investors, especially fund managers, be right this time? Of course, but it's not likely. The last bear market started with strong equity inflows and bond outflows. Cash levels were relatively low. All of this is the reverse now. 

The US dollar is considered the most overvalued in 16 years, a possible tailwind for US multi-nationals and ex-US equities.

* * *

By most accounts, the fall in equities in May was exacerbated by investor fear. That fear does not appear to have dissipated with the rise in equities so far in June.

Let's review several recent studies of sentiment.

First, a study from Bernstein shows that flows out of equities and into bonds so far in 2019 is the most extreme in more than 15 years. Enlarge any image by clicking on it.

What The New High In The Advance-Decline Line Means For Stocks

Summary:  The cumulative advance-decline (A-D) line for both the NYSE and SPX made a new all-time high (ATH) last week. That's good news for stocks, as they most often move higher in the following weeks/months, also to new highs.

This is probably the best way to use the A-D line in equity research. Other common uses of A-D line are fraught with issues.

For example, while it's true that the A-D line has often weakened before stocks have encountered a major decline, you'll need hindsight to make use of this information. For every time a weakening A-D line has signaled a major fall it has signaled nothing special at least twice as often. "Negative divergences" happen all the time.  In real-time, it is impossible to know when a divergence is worth paying attention to.

* * *

Last week, the cumulative advance-decline (A-D) line for both the NYSE and SPX made a new all-time high (ATH). The A-D line sums the net number of stocks moving up on the day added to yesterday's total.  The idea is that when the A-D line is rising, more stocks are moving higher and breadth is considered healthy. In other words, it's a bullish sign for stocks.

Let's start with the good news.

The charts below show every "breakout" in the NYSE A-D line to a new high (top panel) and what happened next to SPX (lower panel) in the past 30 years. What we find is that in every case, SPX has moved higher in the weeks/months ahead. Enlarge any chart by clicking on it.

June Macro Update: Employment and Housing Strong, Manufacturing Weak

Summary: It's been a noisy few months for macro. The prolonged government shutdown in December significantly delayed many data reports. Into this mess, several reports were ugly:

Retail sales in December fell into yoy contraction for the first time since 2009. 

New employment in February fell to the lowest level since 2010. 

New home sales growth in December dropped 14% yoy, the lowest rate since 2011.

That weakness now looks anomalous: the data from the past month mostly point to positive growth. A recession starting in 2019 is unlikely.

The bond market sees continued growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (dots). The lag between inversion and the start of the next recession has been long: at least 7 months and in several instances as long as 2-3 years. On this basis, the current expansion will likely to last through 2019 at a minimum (from JPM). Enlarge any image by clicking on it.

Don't Fear The First Rate Cut

Summary:  The Fed may soon cut rates and that prospect is making investors nervous. Is the start of easing necessarily bad for equities? In short, probably not, at least not immediately. There's more to it than that.

Equities have most often risen after the first rate cut. The only times when equities have consistently traded lower was when they were already doing poorly.

Moreover, the economic data had already been persistently weak for many months (even years) prior to the times when the first rate cut was followed by a recession and an equity bear market.  That's not at all the case this time, making it similar to years like 1984, 1995 and 1998 when rate cuts were subsequently reversed with further rate hikes.

There are never any guarantees but it's probably different this time, in a good way.

* * *

The Fed is now expected to cut its overnight rate 3 times in the next year (from Jim Bianco). Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  US equities rose four months in a row and ended the month of April at new all-time highs (ATH). They then fell 4 weeks in a row during May, losing more than 6%.

So far, this is not that unusual. Almost every year has a drawdown greater than 5%, and most have at least 3 of these. What was unusual was the calm and steady rise from January through April, not the fall in May.

For the remainder of 2019, the evidence leans bullish. That's not a guarantee or a sure thing. But sentiment and breadth are close to a washout (they could be more so) and the usual set up is a seasonal low in June leading to a rally into July.

Could this time be different? Yes. For one, the US is engaged in a seemingly unending and escalating trade war with two major trading partners. No one knows how this will end and that uncertainty could well cause equities to plunge much further. All the market technicals, sentiment and fundamental data available cannot predict what happens next.

* * *

US equities started May at new ATHs but ended the month more than 6% lower (table from alphatrends.net). Enlarge any chart by clicking on it.

1Q Corporate Results: 3% Earnings Growth Expected In 2019

Summary: Overall, corporate results in the first quarter of 2019 were good, but not great. Sales and earnings growth were 6% and 8%, respectively. Margins rebounded from the end of 2018 but are still below the cycle high made in 3Q18.

Looking ahead, analysts' expectations for 10% earnings growth in 2019 have been revised down to 3%. This estimate will be about right if margins can be maintained at the their 1Q19 level, but if the dollar continues to appreciate, earnings growth could be close to zero and another drop in oil prices could cause earnings to decline.

Valuations are now back to their 25-year average. They are not cheap, but if investors once again become ebullient, there is room for valuations to expand. With earnings growth likely to be negligible, the key for share price appreciation in 2019 is likely to hinge almost entirely on valuations expanding.

* * *

96% of the companies in the S&P 500 have released their first quarter (1Q19) financial reports. The headline numbers were good, but not great. Here are the details:


Sales

Quarterly sales grew 6% over the past year. On a trailing 12-month basis (TTM), sales were 8% higher yoy, a strong result (all financial data in this post is from S&P). Enlarge any image by clicking on it.

Fund Managers' Current Asset Allocation - May

Summary:  Although fund managers are less bearish than they were at the start of 2019, they are far from being bullish.  They are overweight cash. Their global equity allocations are almost a standard deviation below the mean. Their bond allocations are at a 7-year high. A slight majority expect profits to contract and economic growth to fall in the next year.

This is a far cry from 2018, when fund managers came into the year with cash levels at 4-year lows and allocations to global equities at 3-year highs. Global equities ended the year 15% lower.

US and European equity allocations remain low relative to levels seen at prior market peaks. Emerging markets are the consensus long. The US dollar is considered the most overvalued in 16 years, a possible tailwind for US multi-nationals and ex-US equities.

* * *

Among the various ways of measuring investor sentiment, the Bank of America Merrill Lynch (BAML) survey of global fund managers is one of the best, 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 cash and underweight equities. Enlarge any image by clicking on it.

Within equities, the emerging markets are overweight while Europe, in particular, is underweight. The US is close to neutral.

A pure contrarian would overweight equities relative to cash and bonds, and European equities relative to emerging markets. 

Weekly Market Summary

Summary:  SPX, NDX and COMPQ are now all at new all-time highs (ATH). The Russell 3000 and Wilshire 5000, which represent essentially all of US equities, are also at their prior highs. The trend remains higher. Moreover, strong starts to the year and multi-month gains have a very high propensity to lead to further gains in the months ahead and by year end. There are precedents for the index to top now, but those are the exception.

Sentiment has become more bullish. This can certainly mark a top, but the historical record is inconsistent. It's a warning, not a red light.

In the most important respects, breadth is fine.

On balance, all of this leans bullish, but it would be a mistake to assume the indices will just sail higher in the remainder of the year. That can happen, but most often a drawdown much more than the barely 2% seen so far in 2019 will occur, even after a start like the current year.

* * *

US equities continue to grind higher. SPX, NDX and COMPQ ended the week at new ATHs. They have risen in each of the first 4 months of the year. The leader is NDX, which has risen 18 of the last 19 weeks since Christmas Eve (table from alphatrends.net). Enlarge any chart by clicking on it.

April Macro Update: Employment and Housing Rebound

Summary: It's been a noisy few months for macro. The prolonged government shutdown in December significantly delayed many data reports. Into this mess, several reports were ugly:

Retail sales in December fell into yoy contraction for the first time since 2009. 

New employment in February fell to the lowest level since 2010. 

New home sales growth in November dropped 14% yoy, the lowest rate since 2011.

That weakness now looks anomalous: the data from the past month mostly point to positive growth. A recession starting in 2019 is unlikely.

The bond market sees continued growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (dots). The lag between inversion and the start of the next recession has been long: at least 7 months and in several instances as long as 2-3 years. On this basis, the current expansion will likely last through 2019 at a minimum (from JPM). Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  NDX is now at a new all-time high (ATH). Leadership by NDX is a positive for SPX: historically, the risk/reward over the coming weeks and months for SPX has been excellent.

On an equal-weigh basis, both SPX and NDX are also at new ATHs.  Any weakness in breadth is almost exclusively explained by the healthcare sector. The other sectors, aside from utilities, have all reached new YTD highs in the past week.

Volatility has been unusually low so far this year. By one measure, this is one of the least volatile starts to a year in the past 90 years. That's unlikely to last. The largest reaction so far this year has barely been more than 2%. Going back 40 years, no year has seen a lower drawdown and all but two (95%) have seen a drawdown of at least 5%. With SPX now within 1% of its prior ATH, a meatier reaction is odds on in the weeks and months ahead.

* * *

US equities continues to grind higher. With about a week to go in April, SPX, NDX and DJIA are on pace to rise in each of the first 4 months of the year. The leader is NDX, which has risen 6 weeks in a row and 16 of the last 17 weeks since Christmas Eve (table from alphatrends.net). Enlarge any chart by clicking on it.

Advisors Perspectives: The Top 25 Venerated Voices for 1Q 2019

Many thanks to Advisor Perspectives for including the Fat Pitch in its list of the Top 25 Venerated Voices for 1Q 2019, placing ahead of much larger firms such as Invesco, Raymond James, BlackRock, Northern Trust, Pimco and AllianceBernstein. 

Advisor Perspectives’ website currently attracts over 150,000 unique visitors per month, virtually all of them financial advisors serving high- and ultra-high net worth individuals. The full list is here.

Weekly Market Summary

Summary:  SPX and NDX are now just 3-4% from their September all-time high (ATH). On an equal-weigh basis, NDX has already made a new ATH.

This has been one of the 10 best ever starts to a year; over the past 60 years, similar fast starts have consistently led to continued gains in the months ahead.  That doesn't mean stocks will not have an interim setback. But if past is prologue, SPX is likely to gain enough to make a new ATH in 2019.

Macro data weakened in the past half year. A conservative investor with a shorter time horizon wouldn't be wrong to reduce their equity holdings into strength. But the panic over weakening macro is likely to abate and, with fund managers' risk exposure falling to a 2-1/2 year low this month, sentiment supports a continued rise in equities.

* * *

Since Christmas Eve, SPX is up 21%, NDX 24% and RUT 23%. Europe and emerging markets are each up 14% (table from alphatrends.net). Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  NDX, RUT and DJIA have all risen 9 weeks in a row. Long win streaks like these have a very strong propensity to continue higher over the next several months, although an interim period of consolidation and retracement is frequent. That SPX is now back at the top of its trading range from October to early December perhaps makes that outcome likely now as well. But years that start as strongly as 2019 have almost always (more than 90% of the time) added sizable gains the rest of the year.

* * *

Since Christmas Eve, SPX is up 19%, NDX 20% and RUT 25%. NDX, RUT and DJIA have each risen the past 9 weeks in a row (table from alphatrends.net). Enlarge any chart by clicking on it.

4Q Corporate Results: Margins Fall. A Watch Out for 2019

Summary: Overall, corporate results in the fourth quarter of 2018 were good, but not great. S&P sales grew 6% and earnings rose 32%, but profit margins fell to 10.9% from a high of 12.1% in the third quarter. This was the first substantial fall in margins since the "profit recession" in 2015.

Fundamentals have been driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself (meaning, valuations contracted). The strong growth in company profits is not due to a net share reduction (e.g., buybacks) either.

Looking ahead, expectations for 10% earnings growth in 2019 have already been revised down to 5%. This still looks too optimistic: if margins in 2019 remain at the same level as in 4Q18, then earnings growth will be 0%. Dollar appreciation and declining oil prices are additional headwinds that could cause earnings to fall this year.

Valuations are now back to their 25-year average. They are not cheap, but the excesses from early 2018 have been worked off: if investors once again become ebullient, there is room for valuations to expand. However, with earnings growth likely to negligible, the key for share price appreciation in 2019 is likely to hinge entirely on valuations expanding.

* * *

85% of the companies in the S&P 500 have released their fourth quarter (4Q18) financial reports. The headline numbers were good, but not great. Here are the details:


Sales

Quarterly sales reached a new all-time high, growing 6% over the past year. On a trailing 12-month basis (TTM), sales are 9% higher yoy, among the best growth in 12 years (all financial data in this post is from S&P). Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  SPX has now gained 19% since Christmas Eve, while the Nasdaq is up 20% and RUT is up 23%. NDX, RUT and DJIA have all risen 8 weeks in a row.

SPX is now back to within 1% of the top of its trading range from October to early December. It would be very surprising if SPX did not encounter some resistance as it nears 2790-2810. That is made more likely by the fact that consecutive weeks of gains, while bullish longer term, have most often been followed by a period of consolidation and retracement.

The longer term outlook continues improve. Equal weighted indices, which remove the influence of a few, large companies, are outperforming their traditional market capitalization weighted peers. The Nasdaq index, normalized to reduce the influence of FAANG, is just 1.5% from a new all time high (ATH). If those big companies kick into gear, the traditional indices will likewise move back to their ATHs.

The primary characteristic of this rally has been broad participation. This week, the cumulative advance/decline line for the very broad NYSE made a new ATH . This did not happen during any bear market rally over the past 40 years.

* * *

Since Christmas Eve, SPX is up 19%, NDX 20% and RUT 23%. NDX, RUT and DJIA have each risen the past 8 weeks in a row (table from alphatrends.net). Enlarge any chart by clicking on it.

Fund Managers' Current Asset Allocation - February

Summary: Fund managers came into 2018 very bullish, with cash levels at 4-year lows and allocations to global equities at 3-year highs. Global equities ended the year 15% lower.

Since Christmas, global equities have rebounded 10%. How have fund managers responded?

In most respects, fund managers remain very bearish:

They are overweight cash by the highest amount since January 2009, the month before the bear market low.

Their global equity allocations are now the lowest in 2-1/2 years. This is a bearish extreme, similar to 2010 and 2016. 

Their profit expectations are the most bearish in 10 years, and below levels which marked equity lows in 2010, 2011, 2012 and 2016. 

Their global macro growth expectations are the most pessimistic in 10 years, more than at the major equity bottoms in 2011 and 2016.  

They view the US dollar as the most overvalued in 16 years, which has a very good track record of marking a turn to dollar weakness, a tailwind for US multi-nationals as well as ex-US equities.

Their global bond allocations are the highest since the Brexit vote in June 2016,  

US equity allocations are at a 9 month low. European equity allocations are coming off a 6-1/2 year low in January. Emerging markets have become the consensus long.

* * *

Among the various ways of measuring investor sentiment, the Bank of America Merrill Lynch (BAML) survey of global fund managers is one of the best 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 very overweight cash and very underweight equities. Enlarge any image by clicking on it.

Within equities, the emerging markets are overweight while Europe, in particular, is underweight. The US is neutral.

A pure contrarian would overweight equities relative to cash, and European equities relative to emerging markets. 

Weekly Market Summary

Summary:  SPX has now gained 16% since Christmas Eve, while the Nasdaq is up 19%. NDX, RUT and DJIA have all risen 7 weeks in a row. Large, uncorrected gains like these are typically near the outer limit before a period of consolidation/retracement. That period may have started this week.

The persistence of trend like this is typically followed by higher highs ahead. Breadth reached another milestone this week, a condition which in the past 20 years has not occurred during a bear market and has not occurred until after the correction low was already in. This adds further evidence that Christmas probably marked the low for the recent swoon.

The pullback this week started from a backtest of the 200-day MA, the  4th attempt to regain the 200-d since early October. Importantly, the slope of the 200-d is flat, a condition which is unlike those during bear markets; this is typically when SPX is best able to break higher.

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From Christmas Eve to its high this week, SPX gained more than 16% while NDX is up 19%. They have since given back about 2%. NDX, RUT and DJIA have each risen the past 7 weeks in a row. Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  SPX has now gained 13% since Christmas Eve, while the Nasdaq is up 16%. After the recent plunge, it would be normal for the indices to give up most of their gains and retest the lows again. That's been a consistent pattern over the past 40 years. But when a plunge is followed by exceptional breadth like we have witnessed in the past month, a low retest has been unlikely.

Rapid plunges when the economy is still expanding - like now - are typically followed by strong forward returns. Moreover, it is encouraging that emerging markets, which have been the hardest hit by the threat of a trade war, reached a 4 month high this week. Those markets originally bottomed in October and retested those lows in December (a possible basing pattern).

It's certainly possible that some of the rapid gains since Christmas will be given back before SPX moves materially higher. A period of consolidation and retrenchment in the weeks ahead would not be surprising. The trade war isn't the only thing driving the market, but it has clearly been important and further deescalation will likely drive SPX to the top of its October-December range, just as reescalation could plunge it back towards its Christmas low.

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The bounce that started on Christmas Eve took a small pause this week. Still, SPX has gained 13% since the low while the Nasdaq is up 16%. According the Ryan Detrick, this is the market's best January in at least 30 years (table from alphatrends.net).  Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  Since the 20% fall in equities into Christmas Eve, equities have rallied 3 weeks in a row, gaining over 10%. So is the correction over?

Sharp falls of at least 15% have a strong tendency to have their original low retested in the weeks/months ahead. That is true even, as now, a sharp 10% bounce occurs. But what is notable this time is the persistence of the gains each week, and the exceptional breadth (participation) that has driven the indices higher.

This is important because, in the past 70 years, this has never taken place within the context of a bear market. In fact, breadth momentum like this is often associated with the start of new bull markets. Net: the Christmas low may still get retested, but it seems likely to hold and new highs are probably ahead. Nothing in the stock market is ever guaranteed, but this has been the consistent, historical pattern.

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The bounce that started on Christmas Eve continued this week. SPX gained for a third week in a row, adding 2.6%. NDX was up 3% and small caps were up nearly 5%. Volatility fell 10% (table from alphatrends.net).  Enlarge any chart by clicking on it.

Weekly Market Summary

Summary:  Equities fell 20% from their September high into Christmas Eve. Since then, they have rallied almost 8%. While this is encouraging, there were two similar rallies, at the start of November and December, that both fizzled out. What is different this time?

For one, there have been two massive accumulation days in the past week. Second, outflows from risk-seeking equity and credit funds and into safe assets has become the most extreme, by far, in the past 10 years. Third, the volatility index spike on Christmas Eve matches those near the lows in SPX following every major sell off since 2010. Fourth, the valuation de-rating is now the largest outside of a recession since 1994.

Nonetheless, when SPX drops 15-20% or more, it has a strong tendency to retest those lows in the weeks/months ahead.

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2018 ended with a thump. NDX lost 1%, SPX lost 6%, small caps lost 12% and financials (the consensus favorite a year ago) lost 15%.  Treasury bonds also dropped for the year, as did commodities. The only winner in 2018 was volatility (table from alphatrends.net).  Enlarge any chart by clicking on it.

January Macro Update: 2018 Employment Was The Second Best Since 2000

Summary: The macro economic story has started to change. The data from the past month continues to mostly point to positive growth, but there is a very important exception: weakness in housing is apparent. If this persists and other measures, especially employment, start to also weaken, a recession in 2019 is possible.

For now, the bond market sees continued growth. 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 8 months and in several instances as long as 2-3 years. On this basis, the current expansion will likely last into mid-2019 at a minimum. Enlarge any image by clicking on it.