RECENT SENTIMENT READINGS FAVOR THE BULLS
The latest sentiment readings from small investors and fund managers reveal that near-term prospects for stocks favor the bulls. The latest Merrill Lynch fund managers survey, which was conducted prior to last week’s 7% rally and earnings, shows that fund managers have become increasingly confident about the long-term prospects for economic growth, but have turned increasingly bearish about equities. The latest readings from last weeks AAII survey show that small investors remain overly bearish. Both surveys should be viewed as contrarian indicators in a classic case of what Art Cashin would refer to as the markets ability to make the most people look stupid most of the time. In other words, as I often say, when one side of the boat is over capacity it’s best to jump off or move to the empty side.
The current outlook for global growth is at a 6 year high. Based on recent data, this appears to be a bit of a lagging indicator as fund managers became optimistic in 2001, well before real recovery, and turned more bearish in 2003 which was well before the actual global economy weakened.
This optimism is global now as Chart 3 displays. The weakest region going forward is clearly Europe and China is the strongest. There appears to be near universal optimism with regards to the Chinese economy in the coming years.
Expectations for corporate profit have shot up in the most recent quarter. Despite this sharp turnaround, expectations remain well below their highs of 88.
In terms of asset allocation, investors remain fairly risk averse. Bonds and cash are still heavily favored while requities remain an underweight. This likely represents a scenario where investors remain under invested in stocks and over invested in risk averse assets. This has little near-term impact on market direction, but could pose a bullish case for long-term investors.
Alternative assets are more of a mixed bag. Commodities overall remain in no mans land. The Merrill survey says:
“The thirst for commodities was quenched rather quickly as commodity prices tumbled”
Gold and oil both remain neutral holdings for most fund managers. In terms of currencies the fund managers currently believe the Euro and Yen are overvalued while emerging market currencies appear more attractive:
Merrill’s Chief Global Equity Strategist has a few key takeaways:
There is no conviction; investors finding lots of excuses to do nothing. Everyone expecting a further modest equity correction; surprise for investors would be summer rally or a real summer crack in markets.
A big second-half rally in equities is not consensus (but remains our view).
H2 strong dollar + weak commodities + higher equities is even more non-consensus.
Most contrarian longs: Anglo-Saxon real estate; European banks; Japanese domestic demand, global small cap + Korea, Taiwan, Mexico, South Africa in EM.
Most contrarian shorts: EM & China.
Meanwhile, individual investors remain fairly bearish. The latest AAII bullish poll came in at 28% which is a level that has generally favored the long equity trade. All in all, I believe this data is bullish for equity investors. Fund managers and small investors remain too bearish.
Source: Merrill Lynch
I like short EM and China for contrarian shorts, although if I were a global macro hedge fund manager, I would do it by simply shorting an EM ETF, short copper, and probably short AUD vs. USD.
I like long Treasuries for a contrarian long. But US Treasury yields have been rising too along with stocks. I thought the bond market would be able to resist the exhuberance of the equity market.
My other favorite positions do not seem to be contrarian: a falling US equity market, short base metals (slightly contrarian), falling German government bond yields, strong dollar vs. euro and pound,. (I do not know what “overvalued” means; and I most certainly do not like the Big Mac Index as a way of quantifying this. Perhaps wages aren’t competitive in the PIGS nations and they are Europe) . Regarding fund managers who think the Euro is overvalued and the pound is fairly valued, the COT reports currently reveal net long positions in Euro and net short positions in sterling.
If I were a hedge fund manager again, the sentiment indicators a bullish signal for equities. Best to close equity shorts that were initiated during the beginning of June last week, and wait until the market lures more small investors and fund managers backs into taking long positions.
Maybe short 10 year Japanese government bonds at 132 basis points is a nice way to be betting on rising Japanese consumer demand and a falling yen, although corporations there are likely to delever putting downward pressure on interest rates. The trade has a negative cost of carry, but it seems to be relatively low risk.
Prag, do you have any information about the number of fund managers or investors who are inflationist/deflationist?
There are still a lot of caution out there. As you indicated as well when you said people are still underweight equities and overweight cash and bonds. Crashes don’t occur when a lot of people are still cautious. I am waiting for the day when everyone has their stop losses gone and they will decide to just average down until they have no money left if markets go down…
Are you sure about sentiment readings? It seems opposite of what you are saying(check out sentiment meter on right hand side):
http://www.sentimentrader.com/
Aki,
The survey tends to move in line with the ISM prices paid component so its relatively neutral right now. Not much conviction in the inflation or deflation camps.
Dean,
I am not sure how sentimentrader comes up with that indicator. I am just relaying the AAII & Merrill info….
With investors turning bullish in 2001 and bearish in 2003, it seems to me that investors have no idea what they are doing. And watching their sentiment as some kind of meaningful indicator makes no sense.
Nick,
It’s important to note that these reads appear to be more long-term than anything else. The AAII figures are much more volatile and are a much better gauge of near-term price swings.
Ignoring sentiment is a massive mistake in my opinion.
Ignoring any data point is folly, imho.
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