Summary: Fund managers came into 2018 very bullish equities. Cash levels had fallen to the lowest level in 4 years. Allocations to global equities had risen to the highest level in nearly 3 years. Bond allocations were at a 4 year low. Our view at the time was that "this is a headwind to further gains" in equities. That post is here.
Since then, global equity allocations have fallen and cash balances have risen. Investors are no longer at a bullish extreme, but the equity shakeout certainly did not make them fearful.
In the past 8 months, US equities have outperformed Europe by 13% and the rest the world by 5%. Despite this, fund managers remain underweight the US. US equities should outperform their global peers on a relative basis.
Fund managers remain underweight global bonds by the greatest extent in 4 years. US 10 year treasuries have outperformed US equities (NYSE) by nearly 400bp in the past two months.
Let's review the highlights from the past month.
Overall: Relative to history, fund managers are overweight equities and cash and underweight bonds. Enlarge any image by clicking on it.
Within equities, the US is significantly underweight while Europe, Japan and emerging markets are all significantly overweight.
A pure contrarian would overweight US equities relative to Europe, Japan and emerging markets, and overweight global bonds relative to a 60-30-10 basket.
Cash: Investors' cash balance is close to neutral at 4.6% (BAML considers cash levels above 4.5% to be a contrarian long for equities). Cash had been a consistent tailwind for equities until November 2017. A recap:
Fund managers' cash levels rose to 5.8% in October 2016, the highest cash level since November 2001. This set up a contrarian long in equities.
Cash remained near 5% until October 2017. In November 2017, cash fell to 4.4%, the lowest level since October 2013.
Current cash levels are neutral: the bullish tailwind behind the rally that existed between October 2016 and November 2017 is gone, but cash balances are not low enough to be considered a headwind. A drop in cash in the month(s) ahead would be bearish.
A composite measure of risk (based on allocations to cash, higher risk assets and investment horizon) had ticked up to a 2 year high in January before the correction in stocks. It has since fallen to a 6-month low. Investors are not fearful, but the bullish extreme has been worked off.
Global equities: After reaching a bullish extreme in January, global equity allocations have fallen, but investors are not yet fearful. 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, periods which were notable bottoms for equity prices during this bull market.
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 (dashed line and shading). Our view was that "this is a headwind to further gains."
After the recent correction, allocations have fallen to +41% overweight (+0.5 standard deviations above its long term mean). It's no longer at a bullish extreme, but it is still above neutral and the equity shakeout did not make investors fearful.
At the February 2016 equity bottom, 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: 20% expect profits to rise more than 10% in the next year.
Macro expectations have fallen in recent months. Only a net 18% expect a better economy in the next year, down from a net 47% in January. Investors are not bearish, but their bullish perspective has faded.
US equities: US equities are still out of favor - but less so than in January - and should continue to outperform. A recap:
Fund managers were underweight US equities for a year and a half starting in early 2015, during which US equities outperformed.
From December 2016, to February 2017, investors overweighted US stocks. US equities underperformed their global peers.
In September 2017, investors again became bearish US equities, giving them the lowest allocation in 10 years. This largely remained the case through February 2018. US equities outperformed.
Allocations rose to -9% underweight in March (-0.2 standard deviations below its long term mean). This remains a tailwind for the US on a relative basis. Above +20% overweight and sentiment typically becomes a strong headwind (dashed line).
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.
European equities: European equities are still at risk of underperforming. A recap:
Fund managers had been 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 then began to outperform.
Allocations to Europe have been excessively overweight the past year, during which time the region has strongly underperformed.
Allocations fell to +40% overweight in March. This is still well above neutral (+0.9 standard deviations above its long term mean). European equities remain at risk of underperforming.
Emerging markets equities: Emerging market equities are still at risk of underperforming. A recap:
In January 2016, allocations to emerging markets fell to their second lowest in the survey's history (-33% underweight).
As the region outperformed in 2016, allocations rose to +31% overweight in October 2016, the highest in 3-1/2 years. That made the region a contrarian short: 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 has since outperformed.
In March, allocations remain at +41% overweight (the same as in January), near a 7-year high (+0.9 standard deviations above its long term mean). Emerging market equities remain at risk of underperforming. They have performed in-line with the US the past 7 months.
Global bonds: Bonds are a long on a purely contrarian basis. A recap:
In July 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 since then, US 10 year treasuries have outperformed US equities (NYSE) by nearly 400bp.
In March, allocations rose slightly to -64% underweight (-1.1 standard deviations below its long term mean). From a purely contrarian basis, bonds should continue to outperform.
Survey parameters are below.
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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.
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Equities: Over +50% overweight is bearish. A washout low (bullish) is under +15% overweight. More on this indicator here.
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Bonds: Global bonds started to underperform in mid-2010, 2011 and 2012 when they reached -20% underweight. -60% underweight is often a bearish extreme.
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Commodities: Higher commodity exposure goes in hand with improved sentiment towards global macro.
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