Tuesday, August 12, 2014

Fund Managers' Current Asset Allocation - August

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 was reached in July, with fund manager equity weightings at +61% overweight, the second highest since the survey began in 2001. This was a clearly identified risk to near term equity performance (post). Since then, the Euro 350 has dropped 8% and SPX has dropped 5%.

In response, equity allocations have fallen to +44% overweight in August. There's good news and bad news in this.

The bad news first. Is this a washout? No. 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 overexposure like that seen in the past 18 months, a washout low would be marked by an equity weighting under +20% (green circles). By that measure, equities are highly over owned.

Now the good news. The current bull market is nothing if not persistent. Equities have not been less than +36% overweight since early 2013. If this is buy support again, then weakness in August will likely mark a low in the next month like those in February and April.

The other factor in equity bulls favor is that cash levels rose above 5% in August. The number instances is low but cash above 5% has been close to lows in 2002, 2003 and 2012. It was a bit early in 2011 and very early in 2008-09. But overall, this is a positive and would likely be more so with further equity weakness in August.

In the world's largest equity market, the US, equity allocations dropped to +6 overweight from +10% in July. 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%. Again, further weakness in August would like put allocations in the strong buy zone. 

Europe had been the consensus long for 11 months in a row. Exposure in June was +43% overweight, the second highest weighting since June 2007. Since then, the region has strongly underperformed. Allocations dropped in August to +13%. This is the 10-year average, but note how prior reversions have gone far below the mean. 

Managers were -31% underweight EEM in March. This was a strong contrarian buy. In the ensuing months, the region has strongly outperformed. In August, allocations increased to +17% overweight, the highest in 17 months. EEM is still under owned but the fat pitch has passed.

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. It's only marginally higher in August. Bonds continue to be the most hated asset class.

It's worth recalling that in June, 88% of fund managers said they believe US 10-year bond yields will be over 2.5% by year end. Yields were 2.37% last week, the lowest since June 2013.

Now, in August, 78% of managers said they expect short rates to increase in the coming months, the highest since May 2011. This is not a positive for rates: 5 year rates dropped from 2% in May 2011 to 0.5% in the following year. Managers have a very bad track record in predicting short term rates; they have been wrong 8 of the last 9 times they were this confident rates would increase.

Globally, managers are not just overweight equity and underweight bonds, they are overweight the highest beta equity (banks, technology, discretionary) and underweight defensives (telecom, staples, utilities). What is new this month is that cash is also over owned; as stated earlier, this has been a positive for equities.

That is less true in the US than it has been in the past. Tech is no longer the most favored sector; it's now energy and pharma, followed by banks. Still, utilities, staples and telecoms remain very underweighted.

You can see from the data that it should mostly be looked at from a contrarian perspective. Fund managers were underweight 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 underweights are the US, defensive sectors and bonds.

Survey details are below.
  1. Cash (+5.1%): Cash balances rose to 5.1% from 4.5% in July. This is the highest since June 2012. It had 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 (+44%): A net +44% are overweight global equities. In July it was +61%, 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 (-62%): A net -62% are now underweight bonds: it was -64% in July, 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 (+13%): After 11 months in a row as investors' most most preferred region, exposure to Europe dropped to +13% overweight from +35% in July and +43% in June. +46% overweight in October was the highest weighting since June 2007.  
    2. Japan (+30%): Managers are +30% overweight Japan, a sharp increase from +7% in May. It's now investors' most preferred region. Funds were -20% underweight in December 2012 when the Japanese rally began. 
    3. US (+6%): Managers dropped their US weighting to +6% overweight from +10% in July. They had been +30% overweight in August 2013 (the third highest US weighting ever). 
    4. EEM (+17%): Managers increased their EEM exposure to +17% overweight, the highest weighting in 17 months. It had been -31% underweight in March when the rally began; that was a new low since the survey started in 2001. 
  5. Commodities (-5%): Managers decreased their commodity underweight to -5%, the highest in 17 months. It had been less than -15% since early 2013. They were -31% underweight in December, the third lowest on record. The rise in commodity exposure goes in hand with improved sentiment in EEM.
  6. Macro: 56% expect a stronger global economy over the next 12 months, an decrease from 69% in July. January was 75%, the highest reading in 3 years. This compares to just 40% in December 2012, on the eve of the current rally.