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.

Earnings Growth Matched The Rapid Pace of Equity Appreciation in 2017

Summary: S&P sales grew 9% over the past year, the best growth in 6 years. Earnings rose 23%, the best growth in 7 years. Profit margins expanded to a new all-time high of 10.8%. Overall, corporate results in the fourth quarter were very good. Earnings during 2017, in fact, rose as much the SPX index itself.

The outlook for 2018 appears to also be strong. "Baseline" economic growth is about 4-5%. The dollar is depreciating, which could add another 3 percentage points to growth. The new tax reform law, passed in late 2017, is expected to add another 7 percentage points. Finally, rising oil prices are a tailwind for the energy sector. As a consequence, the consensus expects earnings to grow 18% this year.

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. With profit margins already at new highs, it will likely take excessive bullishness among investors to propel equity price appreciation faster than earnings over the next few years.

Bearish pundits continue to repeat several misconceptions. In truth, 90% of the growth in earnings in the S&P over the past 8 years has come from better profits, not share "buybacks." The S&P's price appreciation has been primarily driven by better earnings (60%) not higher valuations (the remaining 40%). The trend in "operating earnings" is the same as those based on GAAP.

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86% of the companies in the S&P 500 have released their fourth quarter (4Q17) financial reports. The headline numbers are very good. Here are the details:


Sales

Overall quarterly sales are 9% higher than a year ago. This is the best sales growth in 6 years (since 2011). On a trailing 12-month basis (TTM), sales are 7% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.