Since Christmas, global equities have rebounded 10%. How have fund managers responded?
In most respects, fund managers remain very bearish:
They are overweight cash by the highest amount since January 2009, the month before the bear market low.
Their global equity allocations are now the lowest in 2-1/2 years. This is a bearish extreme, similar to 2010 and 2016.
Their profit expectations are the most bearish in 10 years, and below levels which marked equity lows in 2010, 2011, 2012 and 2016.
Their global macro growth expectations are the most pessimistic in 10 years, more than at the major equity bottoms in 2011 and 2016.
They view the US dollar as the most overvalued in 16 years, which has a very good track record of marking a turn to dollar weakness, a tailwind for US multi-nationals as well as ex-US equities.
Their global bond allocations are the highest since the Brexit vote in June 2016,US equity allocations are at a 9 month low. European equity allocations are coming off a 6-1/2 year low in January. Emerging markets have become the consensus long.
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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 best 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 very overweight cash and very underweight equities. Enlarge any image by clicking on it.
Within equities, the emerging markets are overweight while Europe, in particular, is underweight. The US is neutral.
A pure contrarian would overweight equities relative to cash, and European equities relative to emerging markets.
Cash: Investors' cash balance is high at 4.8% (BAML considers cash levels above 4.5% to be a contrarian buy for equities, and below 3.5% to be a contrarian sell). This is supportive of further gains in global equities. A recap:
Fund managers' cash levels rose to 5.8% in October 2016, the highest cash level since November 2001. Global equities rose over 30% in the next year.
In November 2017, cash level fell to 4.4%, the lowest level since October 2013. Equities peaked in January and then fell 20% during 2018
Despite the 10% rally in global markets since Christmas, cash allocations remain high in February; this is a tailwind for global equities.
Likewise, fund managers are a net +44% overweight cash (a massive +1.8 standard deviations above its long term mean), the highest overweighting since January 2009, the month before the bear market low. In the context of a bull market, cash should underperform a 60-30-10 basket (equity-bonds-cash).
Global equities: After reaching a bullish extreme in January 2018, global equity allocations have now fallen to a 2-1/2 year low: 6% overweight in February (-1.0 standard deviations below its long term mean). This is supportive of further gains in global equities. A recap:
Fund managers were just +5% overweight equities at their low in February 2016; since 2009, allocations had only been lower in mid-2011 and mid-2012 (notable bottoms for equities). Equities rose 50% in the next 2 years.
By January 2018, equity allocations had increased to +55% overweight, the highest level in nearly 3 years. Outside of 2013-14, over +50% overweight has historically been bearish. Our view at the time was that "this is a headwind to further gains." Equities then fell 20% in the next year.
With the recent correction, equity allocations fell to 6% overweight in February, the lowest in 2-1/2 years. This is a bearish extreme, similar to 2010 and 2016, although at lows in 2011 and 2012, fund managers were underweight equities.
On a net basis, fund managers expect profits to deteriorate in the next 12 months, their most bearish view in 10 years (since November 2008). Negative profit expectations also marked equity lows in mid-2010, late-2011, mid-2012 and early 2016 (arrows).
Similarly, macro expectations have fallen hard in recent months: a net -46% expect a better economy in the next year - the lowest since equities crashed 10 years ago in November 2008 - down from a net +47% in January 2018. This is more pessimistic than the major equity bottoms in 2011 and 2016 (arrows) and is consistent with the recessions in 2001 and 2008. Investors are bearish on the global economy.
US equities: Fund managers are now -3% underweight US equities, the lowest allocation in 9 months. This is neutral (-0.1 standard deviations below its long term mean). A recap:
Similarly, macro expectations have fallen hard in recent months: a net -46% expect a better economy in the next year - the lowest since equities crashed 10 years ago in November 2008 - down from a net +47% in January 2018. This is more pessimistic than the major equity bottoms in 2011 and 2016 (arrows) and is consistent with the recessions in 2001 and 2008. Investors are bearish on the global economy.
Fund managers were underweight US equities for a year and a half starting in early 2015, during which US equities outperformed.
By December 2016, investors were very overweighted US stocks: the region underperformed over the next 8 months.
In September 2017, investors again became bearish US equities, giving them the lowest allocation in 10 years. US equities outperformed over the next year.
By November 2018, fund managers were +14% overweight - an extreme (+0.9 standard deviations above its long term mean). The US underperformed the next two months.
Note that the relationship between performance and weighting worked less well in the prior expansion cycle (2003-07) as emerging markets outperformed developed markets by about 5 times.
Fund managers were excessively overweight European equities in 2015-16, during which time European equities underperformed.
That changed in July 2016, with the region becoming underweighted for the first time in 3 years. The region outperformed during the next year.
Allocations to Europe were excessively overweight from mid-2017 to mid-2018, during which time the region underperformed.
Allocations fell to just -11% overweight in January, a 6-1/2 year low. This is when the region started to outperform in 2012, 2014 and 2016-17 (green arrows).
In January 2016, allocations to emerging markets fell to their second lowest in the survey's history (-33% underweight). The region outperformed over the next 10 months.
By October 2016, allocations had risen to +31% overweight, the highest in 3-1/2 years. Emerging equities then dropped 10% in the next two months.
Allocations fell to -6% underweight in January 2017, making the region a contrarian long again: the region outperformed over the next year.
By April 2018, allocations had risen to +43% overweight, near a 7 year high: the region underperformed over the next 6 months.
By November 2018, allocations were -13% underweight. The region has strongly outperformed since.
Global bonds: Fund managers are now -36%% underweight bonds (+0.4 standard deviations above its long term mean), the highest allocation since the Brexit vote in June 2016. Bonds are at risk of underperforming a 60-30-10 basket. A recap:
In June 2016, global bond allocations rose to -35% underweight, nearly a 3-1/2 year high. Bonds subsequently underperformed a 60-30-10 basket.
In January 2018, allocations to bonds dropped to -67% underweight (-1.2 standard deviations below its long term mean), a 4 year low. This was a capitulation low, and US 10 year treasuries subsequently outperformed US equities (NYSE) over the next 6 months.
In November, allocations fell to -58% underweight, among the lowest in 10 years: treasuries outperformed US equities over the next two months.
In November, 70% of fund managers expected higher inflation over the next 12 months; this was near a 14 year high. Since then, inflation expectations have collapsed by the largest amount since the depths of the financial crisis in October 2008 (first chart). As in the past, a strong consensus view on inflation preceded a drop in US 10-year yields in the following months (second chart).
Lower inflation expectations often goes in hand with lower commodity allocations: in February, fund managers' dropped exposure to a net -7% underweight (-0.3 standard deviations below its long term mean). This is neutral.
Dollar: The US Dollar is considered the most overvalued in 16 years (+1.8 standard deviations above its long term mean), a possible tailwind for US multi-nationals and ex-US equities. A recap:
Since 2004, fund managers surveyed by BAML have been very good at determining when the dollar is overvalued (arrows).
In March 2015, they viewed it as overvalued for the first time since 2009; the dollar index fell 7% in the next two months.
In late 2015, they viewed the dollar as overvalued and the index lost 8%.
In late 2016, they again viewed the dollar as overvalued and the index lost 7%.
The dollar is now considered the most overvalued since 2002. Risk is to the downside. A weaker dollar benefits US multi-nationals as well as European and emerging markets equities.
- Cash: The typical range is 3.5-5.0%. 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% overweight is bearish. A washout low (bullish) is under +15% overweight. More on this indicator here.
- Bonds: Global bonds started to underperform in mid-2010, 2011 and 2012 when they reached -20% underweight. -60% underweight is often a bearish extreme.
- Commodities: Higher commodity exposure goes in hand with improved sentiment towards global macro and/or inflation.
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