Summary: Global equities are more than 25% higher than in February 2016. A tailwind for this rally has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.
That's no longer the case. Fund managers became bullish again in December, and remain so now. Optimism towards the economy has surged to a 2-year high. Cash remains in favor (a positive) but global equity allocations are back above neutral for the first time since late 2015. Another push higher and excessive bullish sentiment will become a headwind.
The US is the most overweighted equity market on a relative basis. Emerging markets are the most underweighted.
Findings in the bond market are of greatest interest. Fund managers' allocations to global bonds are now at prior capitulation lows. Moreover, inflation and growth expectations have jumped to the highest level since early 2011, after which US 10-year yields fell in half over the next several months.
The dollar is considered the most overvalued in the past 10 years. Under similar conditions, the dollar has fallen in value in the month(s) ahead.
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 $550b 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 (here).
Let's review the highlights from the past month:
Cash: Fund managers' cash levels dropped from 5.8% in October 2016 to 4.9% in February. Recall that 5.8% was the highest cash level since November 2001. Cash remained above 5% for almost all of 2016, the longest stretch of elevated cash in the survey's history. Some of the tailwind behind the rally is now gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish.
Global equities: 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. Allocations in February have jumped to +39% overweight, a 13-month high. This is now slightly above neutral (0.4 standard deviation above the long term mean). Over +50% overweight has historically been bearish (dashed line).
In February 2016, 16% of fund managers expected a weaker economy in the next 12 months, the lowest since December 2011. They are now optimistic: 59% expect a stronger economy in the next year, near a 2-year high. Pessimism explained their prior low allocation to equities and high allocation to cash; that has now changed.
US equities: US exposure had been near an 8 year low during the past year and a half, during which US equities outperformed. US equities have been under-owned. That's changed. In February, fund managers were +13% overweight (the same as the last 2 months). This is 0.8 standard deviations above its long term mean. Bearish sentiment is no longer a tailwind for US equities. Above +20% overweight and sentiment would become a headwind (dashed line). Close, but not yet.
European equities: Fund managers had been excessively overweight European equities for more than a year in 2015-16, during which time EZ equities underperformed. That changed in July, with the region becoming underweighted for the first time in 3 years. That improved to +23% overweight in February. This is neutral (0.3 standard deviations above its long term mean).
Japanese equities: Allocations to Japan had been falling in 2016 after excessive bullishness in 2015. Allocations fell to -8% underweight in September, the lowest since December 2012. Now, allocations have jumped back to +20% overweight. This is 0.6 standard deviations above its long term mean. Bullish sentiment is close to becoming a headwind (dashed line)
Emerging markets equities: 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, the highest in 3-1/2 years. That made the region a contrarian short. Emerging equities then dropped 10% in the next two months, and allocations fell -6% underweight in January, making the region a contrarian long again. This month, allocations improved to +5% overweight. This is still 0.6 standard deviations below its long term mean.
Global bonds: Fund managers are -59% underweight bonds, a fall from -35% underweight in July (which was near a 3-1/2 year high allocation). This is 0.9 standard deviations below its long term mean. A capitulation low in the past has often occurred when bonds were -60% underweight (red arrows and dashed line). In other words, bonds are now a contrarian long. Note the failure in 2013.
Of note, fund managers' inflation and growth expectations have jumped to the highest level since early 2011. This explains some of the sell-off in bonds in the past several months. It's notable that yields fell (bond prices rose) under similar circumstances in 2011 (highlights).
Commodities: Allocations to commodities are now near a 4-year high (+3% overweight). This 0.4 standard deviations above its long term mean. In comparison, a year ago in February 2016, allocations were near one of the lowest levels in the survey's history (-29% underweight). The improvement in commodity allocations goes together with increased macro optimism.
Sectors: Relative to history, managers remain overweight cash, but less so than in the past year and a half. Like last month, managers are more overweight equities than bonds, a change from the past several months. The allocation to equities would be higher if it were not for a large underweighted position in the UK. US equities are overweighted relative to history.
Fund managers' risk appetite had been well below the mean during 2016; during the current bull market, risk appetite had only been materially lower in mid-2011 and 2012, relative lows from which equities rose strongly in the following months. That has now changed, with risk appetite at 15-month highs, rising above neutral relative to the long term mean for the first time since late 2015. Risk appetite is the average of fund managers cash, investment horizon and investment risk (e.g., equity allocation and sector weighting).
Dollar: Since 2004, fund managers surveyed by BAML have been very good at determining when the dollar is overvalued. In March 2015, they viewed it as overvalued for the first time since 2009; the dollar index fell from 100 to 93 in the next two months. In late 2015, they again viewed the dollar as overvalued and the index lost 7%. Fund managers view the dollar as overvalued now again (and by the highest amount in 10 years). Under similar conditions (highlighted in green), the dollar has fallen in value in the month(s) ahead.
Survey parameters are below.
- 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 especially EM equities.