Remarkably, allocations to cash in September are as high as in February and allocations to equities are now even lower. Investors have jumped into the safety of bonds, with allocations rising to a 3 1/2 year high in June and July. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.
Allocations to US equities had been near 8-year lows over the past year and half, during which the US outperformed most of the world. After rising the past two months, allocations fell again to underweight in September. Bearish sentiment remains a tailwind for US equities. European equity markets, which had been the consensus overweight and also the world's worst performing region, are now underweighted relative to their long term mean. Investors are chasing the world's best performing region - emerging markets - which now have their highest overweight in 3 1/2 years.
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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.
Cash: Fund managers cash levels at the equity low in February were 5.6%, the highest since November 2001 and higher than at any time during the 2008-09 bear market. Cash has remained high ever since: it peaked at 5.8% in July and is only modestly lower in September at 5.5%. High cash levels are supportive of further gains in equities in the month(s) ahead. Enlarge any image by clicking on it.
Global equities: Fund managers were just +5% overweight equities at their low in February; since 2009, allocations had only been lower in mid-2011 and mid-2012, periods which were notable bottoms for equity prices during this bull market. Despite the rally since February, allocations in September are even lower, at +1% overweight. This is 1.1 standard deviations below the long term mean, and supportive of further gains in equities in the month(s) ahead.
Equity allocations relative to cash are at a 4-year low and at levels similar to 2002/03 and mid-2011 and 2012 before significant equity rallies.
US equities: US exposure had been near an 8 year low during the past year and a half, during which US equities outperformed. US equities have been under-owned. After rising the past two months, allocations fell again to -7% underweight in September. Bearish sentiment remains a tailwind for US equities.
European equities: Fund managers had been excessively overweight European equities for more than a year, during which time EZ equities underperformed. That changed in July, with the region becoming underweighted for the first time in 3 years. That improved slightly to +5% overweight in September. This is 0.4 standard deviations below its long term mean. EZ equities have outperformed in the past 3 months since becoming underweighted.
Japanese equities: Allocations to Japan have been falling in 2016 as the region has underperformed. Allocations fell to -8% underweight in September, the lowest since December 2012) and 0.5 standard deviations below its long term mean.
Emerging markets equities: In January, allocations to emerging markets fell to their second lowest in the survey's history (-33% underweight), an extreme comparable only to early-2014 from which the region began to strongly outperform for the next half a year. Allocations have since risen to +24% overweight, the highest in 3.5 years. This is now equal to its long term mean. The region has outperformed the rest of the world so far 2016. There is room for exposure to increase further but allocations are now above where the rally in mid-2014 failed.
Global bonds: Fund managers are -45% underweight bonds, a fall from -35% in July (which was near a 3.5 year high allocation). This is neutral relative to the long term mean. Bonds outperformed in the 10 months before the current equity rally began in February, as allocations increased from -64% underweight in December (a 2-year low). Note that bonds have historically started to underperform when allocations rise to -20% underweight (red shading).
In February, 16% of fund managers expected a weaker economy in the next 12 months, the lowest since December 2011. Investors are still pessimistic, with only 26% expecting a stronger economy in the next year. This explains the low allocations to equities and high allocations to cash.
Commodities: Allocations to commodities remained near a 3.5 year high at -8% underweight. This is neutral relative to the long term mean. In comparison, in February, allocations were near one of the lowest levels in the survey's history (-29% underweight). The improvement in commodity allocations goes together with that for emerging markets.
Sectors: Relative to history, managers are extremely overweight cash. They are far more weighted towards bonds than equities. Overall, this is very defensive positioning.
In July, fund managers risk appetite was the lowest since July 2012, a level from which SPX rose 10% over the following two months.
Survey parameters are below.
- Cash: 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.
- Equities: Over +50% is bearish. A washout low (bullish) is under +15%. More on this indicator here.
- Bonds: Global bonds started to underperform in mid-2010, 2011 and 2012 when they reached -20% underweight.
- Commodities: Higher commodity exposure goes in hand with improved sentiment towards EM.
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