Fund Managers' Current Asset Allocation - November

Summary: Global equities have risen 18% so far in 2017 and yet, until this month, fund managers have held significant amounts of cash and been, at best, only modestly bullish on equities. All of this has suggested lingering risk aversion.

That has now changed. Cash levels have fallen to the lowest level in 4 years. Allocations to global equities have risen to the highest level in 2-1/2 years. In most respects, investors are now bullish.

In the past 6 months, US equities have outperformed Europe by 10% and the rest the world by 3%. Despite this, fund managers remain underweight. US equities should outperform their global peers.

Fund managers are underweight global bonds, nearly to an extreme that has often marked a capitulation low in the past. Only 5% of fund managers believe global rates will be lower next year, a level at which yields have often fallen.

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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 overweight equities and underweight bonds. Cash is now neutral. Enlarge any image by clicking on it.

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

Solid Sales Growth and Margins At New Highs Drive 3Q17 Results

Summary: For the third quarter (3Q17), S&P earnings rose 12% yoy, sales grew 6% and profit margins expanded to new all-time highs.

These strong results are not due to the rebound in oil prices. Sales for the sectors with the highest weighting in the S&P have grown an average of 7% in the past year and 19% in the past 3 years. Moreover, margins outside of energy have expanded to a new high of 10.8%.

Bearish pundits continue to repeat several misconceptions: that "operating earnings" are deviating more than usual from GAAP measurements; that share reductions (buybacks) are behind most EPS growth; and that equity gains are unreasonably out of proportion to earnings growth. None of these are correct. Continued growth in employment, wages and consumption tell us that corporate financial results should be improving, as they have in fact done.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the late 1990s technology bubble. With economic growth of 4-5% (nominal) and margins already at new highs, it will take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate. At this point, lower valuations are a notable risk to equity returns.

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92% of the companies in the S&P 500 have released their 3Q17 financial reports. The headline numbers are good. Overall sales are 6% higher than a year ago, the second best growth rate in nearly 6 years. Earnings (GAAP-basis) are 12% higher than a year ago. Profit margins are at a new high of 10.2%, exceeding the prior peak from 2014.

Before looking at the details of the current reports, it's worth addressing some common misconceptions that are regularly cited.

First, financial reports are said to be fake. This complaint has been a feature of every bull market since at least the 1990s. In truth, the trend in GAAP earnings (red line) is the same as "operating earnings" (blue line; all financial data in this post is from S&P). Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  US equities continue to make new all-time highs (ATHs) and the outlook into year-end is favorable. This week's interim fall of nearly 1% followed by a strong rise into the close demonstrates the market's continued resiliency. It might also indicate waning upward momentum. There remain a number of reasons to suspect that more weakness is ahead, although this is likely to be only temporary.

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SPX, COMPQ, NDX and DJIA all made new ATHs again this week (on Wednesday).  The dominant trend remains higher. Enlarge any image by clicking on it.

Weekly Market Summary

Summary:  The major US indices closed at new all-time highs (ATH) again this week, led by the surging technology-heavy Nasdaq. SPX is now higher 7 months in a row; that level of momentum has not marked a bull market high.

Several short-term studies - using trend, sentiment, volatility and breadth - suggest a lower close than today may be ahead in the next few weeks. Any weakness is likely to be temporary.

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SPX, COMPQ, NDX and DJIA all closed at new all-time highs (ATH) again on Friday.  The dominant trend remains higher. Enlarge any image by clicking on it.

November 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.