“The tactical pain trade is higher yields and higher stocks”, BofA’s Michael Hartnett wrote, in the June edition of his popular Global Fund Manager survey, which grabbed all manner of headlines on Tuesday thanks in no small part to what it tipped about rampant bearishness among respondents.
The notables from the June survey are so many that it was difficult, on the fly, to decide what to highlight first – everything is a highlight. In addition to the findings discussed in the two linked posts above, note that June saw, to quote Hartnett, “the second-largest drop in equity allocation ever [while] FMS relative allocation of equities over bonds dropped to the lowest since May ’09.”
Over the first half of 2019, analysts have variously described the rally as a “flow-less” surge, lacking participation from key investor cohorts and, indeed, the assumption that those who have been gun shy will eventually get pulled/forced in has been a pillar of the bull case for months. It would appear that the renewed threat of an all-out trade war and a global recession has exacerbated this dynamic.
After documenting how factor behavior in equities has mirrored the “slow-flation” theme you’d expect to be in the driver’s seat given the environment, Nomura’s Charlie McElligott on Tuesday rolled out a series of factoids to help flesh things out.
“AAII Equities ‘Bulls’ currently at just 26.8%, a nearly -2SD reading over the past decade”, he wrote, adding that meanwhile, leveraged funds are “continuing to press shorts in US equity futures [with] -$17.9B almost entirely in SPX futures on week through 6/11/19, and now a cumulative -$52.8B of futures shorts across SPX / NDX / RTY, YTD.”
He goes to reiterate that the Value/Growth ratio is still sitting at an all-time low, indicative of investors simply throwing in the towel on cyclicals and moving into secular growth.
The Long-Short crowd’s beta to the S&P is now in just the 3.9%ile on a 1-month rolling basis since 2003. As for fund flows, you already know the story. It’s all about the end-of-cycle trade, hence the “flow-less” character of the equity rally. Here’s McElligott, recapping:
Fund flows YTD tell of the capitulation into “end of cycle” view from investors: +$200B into Global Bond Funds on top of +$121B into Global IG already YTD. 9.5 year / post-GFC highs in Money Market fund assets, with YTD $inflows to MM at +$155B. -$152B of redemptions from Global Equities Funds YTD.
In the June fund manager survey, BofA’s Hartnett describes a “huge bearish rotation to bonds, cash, staples, utilities, and huge rotation away from equities, banks, [the] Eurozone and tech”, consistent with a move away from cyclicals.
It’s a “total buy-in to the ‘slow-flation’ narrative, i.e., Long Duration in both fixed income and equities”, Nomura’s McElligott remarked, citing (again) the risk barbell of “Long Low Volatility and Secular Growth vs. Short Value/Cyclicals” as a way to steer clear of the turning of the global cycle.
Unsurprisingly, “Long US Treasurys” was the “most crowded trade” in the fund manager survey, and to that you could add any of the multiple expressions on the Fed cut narrative which have been incessantly bid of late. June marked the first time ever that “Long US Treasurys” topped the most crowded list.
That’s obviously consistent with the deteriorating macro outlook, and as Hartnett notes later in the survey, “just 9% of FMS investors expect higher global CPI in the next 12 months, down 30ppt MoM, the most bearish FMS inflation outlook since Aug’12.” At the same time, nearly three quarters of respondents see below-trend growth and below-trend inflation over the next year. That’s just more fodder for the bond longs.
As you might surmise from the dour outlook, bond infatuation and equity aversion, fund managers are worried about the possibility that monetary policy might have reached the limits in terms of policymakers’ capacity to reflate the global economy. “Policy impotence” was flagged as the second biggest tail risk, behind only the trade war.
Of course, all of the above leaves a whole lot of folks exposed to a Fed that over-delivers. On one hand, central bank dovishness is just fuel on the fire for the bond rally (we saw that on Tuesday following Draghi’s comments in Sintra). But, in the event policymakers manage to convince the market that they are not, in fact, impotent and/or the idea that a trade truce is in the offing becomes the consensus view, the “worst-case scenario” positioning described above is at risk of getting caught offsides.
“The risk is that there is considerable chance of again being caught ‘flat-footed’ by a heavy-handed central bank policy response (regardless of macro)”, McElligott said, in the same Tuesday note cited above. Central banks have over-delivered this year, he reminds you, meaning there is scope “for an equities ‘right tail’ being priced back into the collective imagination.”
As far as what might happen if Powell were to chance the unthinkable (i.e., a deliberate hawkish surprise), well, suffice to say fire and brimstone from Trump’s Twitter feed might be the least of the Fed chair’s concerns.
“With current dovish Fed pricing, potential policy disappointments increase the risk of rate shocks, especially given the strong equity performance this month, which was at least in part due to expectations for easier monetary policy”, Goldman wrote late Monday.
“Implied rates volatility has also increased, in particular on shorter maturities [and] historically, sharp increases in US rates can weigh on equities and drive a more positive equity-bond correlation”, the bank went on to caution.
As if that’s not enough to make you nervous, do recall that stocks moved lower in 1990 and 1992, both times when the Fed tried to walk back market expectations for cuts.