Urban Carmel | Sep 13, 2017 06:21AM ET
Summary for September: Global equities have risen 12% in the past 6 months and 17% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering risk aversion. They have become more bullish towards equities, but not excessively so with their hedging activity near a 10 month high.
Allocations to US equities dropped to their lowest level in 10 years (since November 2007) in September: this is when US equities usually outperform. In contrast, weightings towards Europe and emerging markets have jumped to levels that suggest these regions are likely to underperform on a relative basis. These weightings also suggest that Europe and/or emerging markets are likely to be the source for any global "risk off' event. Notably, the S&P 500 has outperformed Europe's STOXX 600 by 10% the past four months.
Fund managers are modestly underweight global bonds.
The US dollar has gone from overvalued a few months ago to the most undervalued in nearly 3 years. Fund managers had viewed the dollar as overvalued starting in November 2016; since then, the dollar has lost about 8%. Contrarians should be alert to a change in direction for the dollar.
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.
Overall: Relative to history, fund managers are very overweight cash and underweight bonds. Their equity allocation is modestly overweight.
Cash: Cash remains high at 4.8% in September (BAML considers cash levels above 4.5% to be a contrarian long for equities). This is still supportive of further gains in equities. A recap:
Similarly, a composite measure of risk (based on allocations to cash, higher risk assets and investment horizon) is only neutral despite the long rally in equities. This also supports further gains in equities.
Global equities: Despite a 19 month rally, equity allocations are only slightly above neutral. There is room for further gains. A recap:
Outside of 2013-14, over +50% overweight has historically been bearish (dashed line and shading).
Similarly, only a net 27% of fund managers have not bought equities hedges (i.e., downside protection). Current levels are similar to those prevailing prior to the US election last autumn. This further indicates a lack of complacency.
In February 2016, more than 20% of fund managers believed profits would be weaker in the next 12 months, the lowest since 2012. They are now more optimistic, but not exceptionally so: 34% expect stronger profits in the next year (red line). Pessimism explained their prior low allocation to equities and high allocation to cash; that has changed a bit.
More (but only a net 25%) expect a better economy in the next year. This explains their generally improved enthusiasm for equities but, like cash levels, investors are far from excessively bullish.
Above +20% overweight and sentiment typically becomes a strong headwind (dashed line).
Fund managers' positioning in US equities versus Europe is the lowest since April 2007 (1.5 standard deviations below its long term mean), after which the region began to outperform.
Likewise, fund managers' positioning in US equities versus emerging markets is the lowest since November 2007 (1.5 standard deviations below its long term mean), after which the region began to outperform.
European equities: European equities are at high risk of underperforming. A recap:
Emerging markets equities: Emerging market equities are at risk of underperforming. A recap:
Global bonds: Bonds are a modest contrarian long. A recap:
Fund managers' growth expectations relative to inflation are the highest on record (blue line). Similar (but lower) peaks in 2Q 2010, 1Q 2011, 2Q 2014 and 2Q 2015 preceded a fall in yields (second chart).
Commodities: Allocations to commodities dropped to a 1-year low in June (-15% underweight) before rebounding in September (-4% underweight). This is equal to its long term mean (neutral).
Dollar: The US dollar has gone from overvalued to the most undervalued in nearly 3 years. A recap:
Survey parameters are below.
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