Has Equity Positioning Peaked? (It Depends)

If the question is whether there’s room for market participants to increase their equity exposure with stocks at record highs, the answer is “it depends.”

Specifically, it depends on which market participants you mean.

I often mention how the vol control universe can provide a kind of “background” bid for stocks as long as spot remains well-behaved and realized vol grinds lower (figure below).

That’s still true. And, more generally, systematic strats still have room to re-leverage.

But, according to one bank’s positioning metrics, discretionary investors may be maxed out. “There is room for systematic strategies’ equity exposure to rise, but whether it does will depend on declines in equity vol and the bond-equity return correlation,” Deutsche Bank’s Srineel Jalagani and Parag Thatte wrote, in their latest asset allocation update. On the bank’s models, vol control funds’ exposure is around 40th percentile, while CTA and risk parity allocations sit in the 52nd and 49th percentiles, respectively.

For risk parity to add more exposure, the stock-bond correlation would need to normalize. “Risk parity funds’ US equity allocations rose during February and March as realized equity vol fell, but remain at the lower-end, weighed down by elevated overall portfolio volatility and by an increasing equity-bond correlation, which would need to revert for them to add,” Deutsche’s strategists said.

For discretionary investors, it’s another matter entirely. Positioning among those cohorts is in the 100th percentile on Deutsche’s measures, creating a marked juxtaposition with the systematic crowd.

For what it’s worth, the trek higher shown by the green line is consistent with ISM. Deutsche noted that the nosebleed reading on discretionary positioning is “in keeping with its historical behavior” vis-à-vis the manufacturing gauge which, of course, rose to the highest since 1983 last month. I called the latest vintage of the survey a “giant, screaming fireball.”

But even as systematic exposure is nowhere near as stretched, the bank’s aggregate positioning metric is close to record highs seen just prior to the implosion of the short vol bubble in February of 2018. The previous month, equities experienced a melt-up amid tax cut euphoria in the US. In other words: The last time Deutsche’s consolidated equity positioning metric (which takes the weighted average of z-scores for positioning and flows indicators) was as elevated as it is currently, the Trump tax cuts had just become law.

The figure (below) shows that half of the measures which comprise the bank’s aggregate metric are in the 95th percentile or above.

Although they aren’t necessarily comparable, it’s worth mentioning that Goldman’s sentiment indicator actually dropped below “stretched” territory recently, while BofA’s pseudo-famous “Bull & Bear Indicator” remains stuck around 7.2, just short of the 8.0 which would be a contrarian sell signal.

How much gas is left in the proverbial tank if the systematic universe were to crank up their exposure to a Spinal Tap-ish “11”?

Not much, according to Deutsche Bank. “If systematic strategies positioning were to rise to its previous peak in December 2017, it would move aggregate positioning higher, but with the bulk of the positioning move behind us, the historical relationship between the S&P 500 and positioning suggests a relatively modest 2.5% market upside from current levels,” they said.