Fund Managers' Current Asset Allocation - February

Summary: Fund managers' cash in February rose to the highest level since 2001, higher than at any time during the 2008-09 bear market This is bullish for equities.

In the past two months, global allocations to equities have fallen from 40% overweight to just 5%. Since 2009, allocations have only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market. This is bullish for equities.

Allocations to US equities remain at an 8 year low, a level from which the US should continue to outperform, as it has during the past 10 months. Europe remains very overweight. Emerging markets were the only region that saw an increase in exposure; it is still very underweighted and the region's recent outperformance should continue.

Among sectors, exposure to industrials fell to the lowest level since August-2011 and banks to the lowest level since December 2012.  Among defensive sectors, allocation to utilities is now the highest since September 2011. From a contrarian perspective, some cyclical sectors may be set up to outperform defensives.

The dollar is considered to be the most overvalued in the past 9 years. Under similar conditions, the dollar has fallen in value.

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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 jumped to 5.6%, the highest since the post-9/11 panic in November 2001, and lower than at any time during the 2008-09 bear market. This is extraordinary. Current levels are an extreme that is normally very bullish for equities. Even November 2001, which wasn't a bear market low, saw equities rise nearly 10% in the following 2 months.

Weekly Market Summary

Summary: The move into the perceived safe havens of treasuries and gold in 2016 appears to have reached a point of short-term exhaustion. That trend might resume, but odds suggest a pause is ahead. If optimism reached a peak in safe havens, pessimism likely reached a trough for equities.  None of this will matter if oil and equities continue to be highly correlated and oil is unable to stop falling. A strong 2-day rally still left oil lower than it was on Tuesday. Unlike last week, equities now have a bottom to trade against.

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SPY had dropped nearly 4% during the week by mid-day on Thursday; it then staged a 3% rip into Friday's close. For the week, SPY ended lower by 0.8%. NDX lost just 0.1%. The big winners were gold and treasuries, gaining 5% and 2%, respectively.

As in recent weeks, equity activity was driven by volatility in oil. At its low on Thursday, oil had lost more than 14% on the week. The subsequent rally in stocks was accompanied by a 10% gain in oil. It's repetitive, but the correlation between oil and equities continues to be very tight, and represents a significant wild card for the days and weeks ahead. Simply put, any bet on a further gain (or loss) in equities seems to be largely a bet on the direction of oil.

Weekly Market Summary

Summary: NDX undercut its January low this week, and Friday's sell off was extreme enough that it is unlikely to mark the low. Negative investor sentiment seems to be feeding on itself, with sell offs leading to historic fund outflows and further sell offs. These extremes have reached a point where they most often reverse. Even if US equities are in a bear market, a rally of 7-10% is likely close at hand. Importantly, there has been no price action that yet suggests a reversal in the short-term trend.

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After rising the past two weeks, during which oil prices rose 20% from their lows, equities fell hard this week. SPY lost 3%, RUT lost 5% and NDX lost 6%. The big winner was gold, which gained 5%. 

Given the close correlation recently between equities and oil, it's no surprise that oil led to the downside, losing 8%. This continues to be the biggest wild card driving the direction of equities.

Perhaps more surprising is that the dollar index fell nearly 3%. Should this continue, this would be a net positive for equities as the repatriated profits of overseas sales benefit from a higher trading partner currency. Naturally, the dollar cost of US products also becomes more affordable with a lower dollar. There is, therefore, a close link between the dollar and revenues for SPX companies: as the dollar falls, revenue growth increases. More on this in a recent post here (chart from Yardeni).

February Macro Update: Outside Manufacturing, Growth Remain Positive, But Slow

Summary: The balance of the macro data from the past month continues to point to positive but sluggish growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

The main positives are in employment, consumption growth and housing:

• Employment growth is close to the best since the 1990s, with an average monthly gain of 222,000 during the past year.  Full-time employment is soaring.
• Recent compensation growth is the highest in more than 6 years: 2.5% yoy in January.
• Most measures of demand show 3-4% nominal growth. Personal consumption growth in 2015 was the highest in 9 years.  
• New housing sales, starts and permits remain near an 8 year high. 
• The core inflation rate ticked up above 2% and to the highest rate since July 2012

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):

• Core durable goods growth fell 4% yoy in December. It was weak during the winter and there has been little rebound since. 
• Industrial production has also been weak, falling -1.3% yoy.

Prior macro posts from the past year are here.

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Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The January non-farm payroll was 151,000 new employees minus 2,000 in revisions. In the past 12 months, the average gain in employment was 222,000. Gains since 2014 have been the highest since the 1990s.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 84,000 in March, as well as the 'disappointingly weak' print in September, fit the historical pattern. This is normal, not unusual or unexpected.

Mid-Week Update

Here are a few mid-week thoughts on the dollar, bonds, industrial production, high yield, corporate profits and the upcoming NFP report.

The dollar fell 1.6% today. This sparked a rebound in US equities mid-day; SPY rose 2.5% from its intra-day low to close positive. In the bigger picture, the dollar index has been moving sideways since early 2015.