Stocktake: Bearish fund managers wary of market rally
A record number of investors say the global economy is in its late-cycle stages
One gets the impression right now that markets, buoyed by the likelihood of US interest rate cuts from an increasingly dovish Federal Reserve, want to go higher. Photograph: Michael Nagle/Bloomberg
The S&P 500 hit fresh all-time highs last week but investors aren’t excited. Far from it, according to Bank of America Merrill Lynch’s (BofAML) latest monthly fund manager survey. The survey is a startling one. Pessimism driven by trade war and recession concerns has resulted in global equity allocations hitting their lowest level since March 2009 following the second-biggest one-month drop on record.
Cash balances have soared from 4.6 to 5.6 per cent, the biggest jump since the US debt ceiling crisis in 2011, while bond allocations have spiked to their highest level since September 2011.
Global growth expectations collapsed by a record 46 percentage points over the last month; a record number of investors say the global economy is in its late-cycle stages; global profit expectations have endured the second-biggest one-month drop on record. This level of pessimism is associated with market bottoms, not tops. The “most bearish survey of investor confidence since the global financial crisis” suggests the “pain trade” is higher bond yields and higher stock prices, says BofAML. That’s echoed by LPL Research strategist Ryan Detrick. “If you were looking for ammo on what could drive things higher should we get any good news”, says Detrick, “this could be it”.
Is a market melt-up on the cards?
The fund manager survey is just the latest data suggesting markets are more likely to melt up than to melt down, as BlackRock’s Larry Fink argued in April. Fink’s point was that while stocks have done very well in 2019, investors have remained cautious, instead piling into bonds rather than equities. More recent data confirms lots of money is still sitting on the sidelines. Sentiment expert and Fat Pitch blogger Urban Carmel points to a Bernstein study showing flows out of equities and into bonds in 2019 are the most extreme in more than 15 years. Equity outflows are the largest on record, according to Deutsche Bank, with stocks tending to post large gains over the following year in past instances mirroring today’s environment.
Ordinary investors, as measured by American Association of Individual Investors (AAII) polls, have been similarly nervy, with pessimism recently hitting extreme levels. Markets may not melt up, of course, but they certainly don’t look toppy. “This is not how bear markets, or even big corrections, begin,” says Carmel.
Market breadth looks healthy
Bulls will also be cheered by strong market breadth. Typically, a handful of outperforming large-cap stocks keep indices aloft in the latter stages of bull markets. Stocks tend to fall into their own individual bear markets in advance of market peaks, so much so that only a small percentage of stocks tend to be at 52-week highs at market tops. That’s not the case right now. The number of 52-week highs has been expanding; according to Renaissance Macro Research’s Jeff DeGraaf, almost a quarter of S&P 500 stocks were recently trading at 52-week highs.
Even before last week’s all-time highs, said DeGraaf, it was clear the “internal strength of this market was far better than people were giving it credit for”. Similarly, the advance-decline line for the main US indices – a breadth indicator tracking the number of advancing stocks minus the declining stocks – hit new highs in advance of last week’s breakout, suggesting higher stock prices were only a question of time. Right now, the bull market looks healthy. Stocks will suffer pullbacks, as they always do, but market action suggests a protracted decline remains unlikely.
New highs are bullish for stocks
New highs make many investors nervous. However, while no one likes the thought of buying near a market peak, the reality is new stock market highs are bullish, tweeted Baird investment strategist Willie Delwiche last week. It is, he added, “more bullish to make new highs than to not make new highs”. Delwiche is right. New highs tend to come in clusters. During bear markets, stocks can go years or even decades without registering new highs, only to then hit hundreds of highs during lengthy bull markets.
Markets have been in a trading range over the last 18 months, so it appears significant indices have finally broken out to new highs, suggesting investors can expect to see another cluster of new highs in 2019 after a long period of consolidation. Certainly, one gets the impression right now that markets, buoyed by the likelihood of US interest rate cuts from an increasingly dovish Federal Reserve, want to go higher.
Last Thursday’s highs came on the same day that saw significant tensions in the Middle East, including a warning from President Trump that declared Iran had made a “big mistake” in shooting a US drone. Those tensions pushed oil prices up 6 per cent, noted influential Allianz economist Mohamed El-Erian, a development that would ordinarily be viewed with “some concern” by investors. Instead, indices hit new highs, suggesting stocks may continue to climb the proverbial wall of worry.