FYI | Aug 22 2011
(This story was originally published on Wednesday, 22th August, 2011. It has now been repeated to make it available to non-paying members at FNArena and to readers elsewhere).
By Rudi Filapek-Vandyck, Editor FNArena
Stockbrokers, funds managers and other "professionals" in the investment community usually suggest it is the retail investor who tends to lose perspective at the wrong time, running scared when financial assets are near the bottom and turning positive too late in rallies. However, a recent global survey amongst large funds managers suggests this month's unprecedented turmoil in equity markets was triggered by funds managers running scared and substantially reducing their exposure to equities.
This, say analysts at BA-Merrill Lynch, offers investors yet another contrarian indicator with history showing equities should now rally in the weeks ahead.
Cash held on the sidelines by these large funds managers has surged to levels last seen in early 2009. The reason? It would appear the main fear was that sovereign debt issues in Europe would trigger another Lehman Bros collapse style of financial markets mayhem. Mind you, worries about the outlook for economic growth remain with an unusually high number of respondents (29%) now anticipating a US recession is but a fait accompli. In the wake of this development, it is probably no wonder expectations about inflation and corporate profits have taken a big turn for the worse. BA-ML reports the changes recorded in this latest survey represent "the biggest monthly collapse… ever".
There are some positives though. Exposure to commodities has equally been reduced, but to a much lesser degree as to equities. Since overall sentiment towards Chinese growth improved for the second month in a row it's probably fair to assume there's a direct correlation between the two.
Overall sentiment towards the US and in particular towards Europe has deteriorated significantly. Global fiscal policy is now described as “restrictive” for the first time since March 2009 and -whatdayaknow– QE3 is back on many funds managers' mind. The survey asked at what level managers thought the Federal Reserve would consider introducing QE3 and the answer is "below 1100" for the S&P500 index. Note the S&P500 closed at 1192 last night, so that should keep the Fed on alert, but also inactive (at least if the prognostication by these global experts is anything to rely upon).
Earlier in the month, when huge swings had become the colour of every day, that 1100 level at times seemed but a short distance away.
Talking about "colour", here's an observation by BA-ML that surely puts the myth about a stable mindset at global funds managers to bed: the reduction in equities exposure in August was the largest recorded by this survey – ever. All in all, global asset allocators are now very overweight cash, modestly overweight commodities, neutral equities and underweight bonds. As far as the remaining equities weighting is concerned, funds managers are now underweight industrials, materials, banks and overweight in consumer staples. All levels concerned are at their highest levels since March 2009.
Mind you, the reduction in exposure to equities involves developed markets the US, Europe and Japan, while overall exposure to Emerging Markets (on the back on improved sentiment towards China) remained largely intact. This is not good news for those emerging markets. BA-ML assumes, and I think this is a fair assumption to make, that if the cash on the sidelines will be redirected to equities, it will go to the abandoned sectors in the developed world equity markets.
To put it in the words of BA-ML, a contrarian trader now would buy equities, Europe, banks, industrials and materials while selling cash, gold, Emerging Markets, tech, staples and healthcare.
The suggestion is one should now be looking to go contrarian.
BA-ML analysts have their own in-house contrarian trading variables, and large cash holdings by global funds managers are one of the key indicators, report the analysts. Historical analysis shows every time their Cash Trading Rule gives a “buy” signal, equities normally rally 6% in 4 weeks (the hit ratio for this signal is 70%, report the analysts). Overall conviction the buy signal will prove its worth again this time around is supported by the observation that a record net 48% of respondents to the survey thinks equities are cheap. (Indicating it was sheer panic all around in the first two weeks of August).
The survey was conducted between 5 and 11 August with 244 respondents participating whom combined have some $718b under management. The survey revealed cash balances jumped from 4.1% to 5.2%; the highest reading since March 2009.
Other noteworthy snippets include some of the answers respondents came up with when asked what kept them awake at night; "more pointless QEs", "premature monetary tightening", "political stupidity" and "petty politics" were all among the answers provided.
Note that key indicators such as expectations for economic growth and asset allocations to equities are both well, well, well below levels indicated in the run up to the Fed's Jackson Hole meeting in late August last year. That was the meeting that triggered a big rally until April this year, with two minor sell-offs along the way.
Regardless of whether history will or will not repeat itself this year (I'd say "not"), all of the above does indicate investors are now positioned in such a manner that it won't take much, in terms of good news, to trigger major rallies for equities and other risk assets. On this basis, one would have to conclude it seems rather unlikely the lows seen earlier this month will be revisited anytime soon with overall risk, on balance, now tilted to the upside.
Merkel? Sarkozy? Anyone listening?
Note also surveys by FNArena and the AIA in Australia already showed investor portfolios contained in excess of 20% in cash, which is probably at an historical high as well.
One black mark from the survey is that Australia remains among the least preferred countries to seek exposure to. No doubt, lacklustre earnings in combination with a strong currency and a faltering tightening bias by the RBA on the back of serious loss in economic momentum are responsible. Investors can seek solace in the wisdom that this too shall pass, eventually.
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)
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