$635 Billion Is The Least Bearish Since Fed Liftoff

Two months ago, I wondered if equity bulls were about to “lose their best friend.”

The thesis was straightforward: Positioning was no longer bearish, which removed a key contrarian tailwind for the stock melt-up.

I’ll recycle some language from the linked article. As spring melted into summer, equities benefited immensely from what Morgan Stanley’s Mike Wilson at one point described as a “180 degree” turn in investor sentiment. The mood among discretionary investors — individual and institutional, retail and professional — improved as stocks ran away higher. Eventually, discretionary positioning caught up to re-leveraging among systematic investors, whose buying helped bolster stocks earlier in the year.

Fast forward several weeks and some are concerned that positioning may now pose a threat to the rally. I’ve been more diplomatic about it, suggesting instead that absent a clear green light or definitive evidence that we have, in fact, entered a new secular bull market, the scope for additional buy-in (figurative and literal) from fundamental, carbon-based investors could be limited.

The latest installment of BofA’s closely-watched Global Fund Manager Survey underscored that latter contention, or at least that was one way to read the results. The bank’s Michael Hartnett called it the “least bearish survey since February of 2022.”

The figure on the left, below, is a “broad measure” of sentiment, based on survey readings for fund managers’ cash positions, equity allocation and growth expectations.

On the right, you can see cash allocations dropping below 5% to the lowest since November of 2021, the peak of the so-called “everything rally.” That threshold is meaningful. Cash levels above 5% are contrarian bullish.

Of course, there’s still a mountain of cash parked in money market funds ($5.5 trillion in the US and some $8 trillion globally), and EPFR’s data shows flows to cash funds are running ahead of Q2’s pace in Q3. But if fund managers are moving off the sidelines to catch an equity benchmark that won’t listen to reason, you can hardly blame them, even if you might call them late to the party (or, less generously, sheep to the slaughter).

Investors who responded to BofA’s poll were the least Underweight equities relative to cash since early last year, which is to say since the onset of Fed hikes. “Peak relative cash” (if you will) or “trough relative stocks” was September of 2022, just prior to the lows for the S&P.

Consistent with record “soft landing” mentions in the news and on social media, as well as data that ostensibly supports the case for a benign outcome to the most challenging macro conjuncture in nearly half a century, the share of respondents to BofA’s poll who don’t see a recession in the next 18 months now exceeds 30%.

Relatedly, three quarters now see either a soft landing or no landing at all.

It’s all too easy to roll out some tired cliché — some version of “What could go wrong?” in the service of suggesting that all of the above is surely a contrarian indicator both for risk assets and the economy. And yet, I’m not sure that’s true. Outside of warning signals from the Fed’s senior loan officer opinion survey, and nebulous predictions about dwindling pandemic savings buffers and the assumed drag on spending from the resumption of student loan payments, the US economy sticks out for a demonstrable lack of canaries. Bears will disagree, but making the case for a US recession in the near-term remains quite difficult.

But, coming full circle, we needn’t necessarily make the recession case to make the bear case for risk assets. As Hartnett noted, under-positioning can’t be the contrarian tailwind for stocks it was during the first half because discretionary investors are no longer under-positioned. Instead, they’re bullish (certainly relative to any point since liftoff), which means the contrarian risk runs in the opposite direction.

Indeed, there’s some evidence that fundamentals-based investors are already trimming positions. Although systematic exposure remains stretched (vol control strats are still waiting on a wider distribution of daily spot outcomes and higher realized vol to de-risk), some measures suggest there’s been a “sharp unwind” among discretionary investors, as Deutsche Bank’s Parag Thatte recently put it, describing a multi-week drop for the bank’s key positioning metric.

As far as tail risks, “High inflation keeps central banks hawkish” topped the list in the August BofA poll. “Long big-tech” was the most crowded trade by a wide margin. Nearly 250 panelists with $635 billion in AUM participated in the survey.