Wednesday, July 23, 2014

Fund Managers' Current Asset Allocation - July

Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $700b in assets.

An extreme in bullish equity sentiment has been reached.  In July, fund manager equity weightings increased to +61% overweight. This is the highest since February 2011 and the second highest since the survey began in 2001.

In the past, when near 60% overweight, the risk/reward for equities has been unfavorable over the next several months (yellow shading). In 2011, SPX rose 2% versus falling 6% over the next 6 months. This culminated in a 20% fall in August 2011. The other prior examples of excessive bullish sentiment also resulted in poor risk/reward over the following months (chart from Short Side of Long).

As we have continually noted, what has been remarkable is how long managers have been highly overweight equities (virtually since the start of 2013). This is longer than any period during the 2003-07 bull market (yellow shading). In the past, after massive overexposure like that seen in the past 18 months, a washout low would be marked by an equity weighting under +15% (green circles). By that measure, equities are highly over owned.

In the world's largest equity market, the US, equity allocations remained +10% overweight in July. Exposure is essentially neutral. Given how strongly the US has outperformed the rest of the world in the past several years, exposure is surprisingly low. It is not over-owned until weightings are +20%.

Europe has been the consensus long for 11 months in a row. Exposure in June was +43% overweight, the second highest weighting since June 2007; it declined to +35% in July. The only higher weighting than June was in October 2013; Eurozone equities traded sideways the following 5 months.

Emerging markets had been underperforming SPX over the past year. Over the past four months, however, EEM has outperformed. In response, managers have increased their exposure to +5% overweight from -31% in March. In the bigger picture, managers are still massively underweight. BAML considers current levels to be a contrarian buy. We agree.

Remarkably, although US bonds have outperformed SPX so far in 2014, fund managers are still hugely underweight. In July, weightings fell to their lowest in more than 6 months. If there is a hated asset class, it's not equities, it's bonds.

It's worth recalling that last month 88% of fund managers said they believe US 10-year bond yields will be over 2.5% by year end. Yields are currently 2.46%.

In July, 71% of fund managers said they believe global core CPI will be higher in the next 12 months. This is the highest percent holding this view since March 2011. In the next 6 months, US 10-year yields fell from 3.6% to 1.7%.

Globally, managers are not just overweight equity and underweight bonds, they are overweight the highest beta equity (banks, discretionary) and underweight defensives (telecom, staples, utilities).

That is equally true in the US, where tech is the most favored sector, by far, and utilities are still very underweighted.

You can see from the data that it should mostly be looked at from a contrarian perspective. Fund managers were overweight EEM more than any other market at the start of 2013, and it was the worst performer in the following year. In comparison, they were 20% underweight Japan in December 2012 and it was the best equity market in 2013.  Now, the big overweight is in Europe and the big underweight continues to be emerging markets, bonds and commodities.

Survey details are below.
  1. Cash (+4.5%): Cash balances remain 4.5%. It has been in a 4.4% to 4.8% range since July 2013. Typical range is 3.5-5%. BAML has a 4.5% contrarian buy level but we consider over 5% to be a better signal. More on this indicator here
  2. Equities (+61%): A net +61% are overweight global equities, the second highest since the survey began in 2001 and the highest since 67% in February 2011. It was +37% in May and +48% in June. A washout low would be under +15%. More on this indicator here
  3. Bonds (-64%): A net -64% are now underweight bonds, a large drop from May (-55%) and the lowest weighting in more than 6 months. In November, it was the second lowest ever (-69%). For comparison, they were -38% underweight in May 2013 before a large fall in bond prices. 
  4. Regions
    1. Europe (+35%): Europe is the most preferred region for the 11th month in a row. Managers are +35% overweight, a sharp drop from +43% overweight in June. +46% overweight in October was the highest weighting since June 2007.  
    2. Japan (+26%): Managers are +26% overweight Japan, a sharp increase from +7% in May. Funds were -20% underweight in December 2012 when the Japanese rally began. 
    3. US (+10%): Managers maintained their US weighting at +10%, up from +6% in May. They had been +30% overweight in August 2013 (the third highest US weighting ever). 
    4. EEM (+5%): Managers maintained their +5% overweight EEM for a second month, the highest weighting in 15 months. It had been -31% underweight in March, which was a new low since the survey began in 2001.  BAML considers current levels to be a contrarian buy.
  5. Commodities (-15%): Managers commodity exposure remains largely unchanged the past several months. It is 1 standard deviation below the 10 year mean. They were -31% underweight in December, the third lowest on record. Low commodity exposure goes in hand with skepticism over EEM.
  6. Macro: 69% expect a stronger global economy over the next 12 months, an increase from 62% in March and April and 66% in June. January was 75%, the highest reading in 3 years. This compares to just 40% in December 2012, on the eve of the current rally.