Market Analysis: Positioning and Sentiment

On Wednesday, Financial Times “Short View” columnist, Miles Johnson, said the following:

“Stock market investors have spent vast amounts of effort this year worrying about why people are not worried enough.”

“In fact, large institutional investors are by some measures more nervous today than at any time since the dotcom bubble. The most recent BofA Merrill Lynch fund manager survey, which polls investors responsible for almost $600bn of assets, showed that 44 per cent of respondents said equities were today overvalued, which was the highest number since 1999.”

“Yet if fund managers really are so worried, then the cost of options to protect against a correction, and therefore the Vix, should be higher. Perennial pessimists may soon have to accept something even more worrying than all of this ongoing lack of worry – that their beloved Vix may no longer be a meaningful indicator of anything at all.”

Where to begin…

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Johnson is likely correct in his implicit assumption this bull market still has a ways to go. But he is correct for the wrong reasons. Incorrect assumption A): The VIX is not broken; rather, it is a sign of a healthy bull market, as in broad-based bull market rallies volatility, by definition, is depressed. B) Investors cannot, by definition, be “nervous” as they bid up stocks to all-time high valuation levels. Perhaps Johnson is picking up on the mainstream media-derived notion that this is the “most hated bull market of all time”. But again, this is false, as individuals and institutional investors are heavily pegged over to equities. It is impossible to overstate how wrong the notion that somebody clicking “BUY” for a stock at its all-time high is somehow fearful. C) The BAML survey Johnson cites, based on history, cannot be used as a contrarian indicator. In other words, investors say one thing and do the other…

…Everyone and their brother knows the stock market is at all-time high valuation levels. Yet due in large part to price momentum and near-term fundamental “visibility”, investors are very comfortable being overweight equities. But vice versa at market lows. In 2009 and 2011 – to use two extremes – everyone and their brother knew stocks were very cheap, yet due to momentum and a lack of near-term fundamental “visibility” investors were dramatically underweight equities.

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The June 2017 BAML “Global Fund Manager Survey”, cited in the above-referenced FT column, is instructive as to how fundamentals, expectations of fundamentals and markets both relate to each other and move in cycles.

The following chart overlays market participants’ view of global profits with their view of equity valuation. As Larry Kudlow likes to say, corporate profits are the “mother’s milk” of the equity market, thus the tight correlation of the two charts makes sense. The problem is that with so many participants of the view that there is limited room for valuation upside, markets are quite vulnerable to a decline in profits (this is noted by BAML on the side). And while one blip does not make a trend, as demonstrated in the 2013 run-up in global profit expectations, profit expectations have begun to roll over a bit.

Corroborating this view of potential vulnerability is the following set of charts on profits, margins and the global economy, all of which appear to be rolling over.

On the bullish side, however, is the following chart that shows cash positions have ticked up, which is not typical for a market top. (Though one could argue this is more than likely due to “bond cash”.)

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And to finish, I would add this chart of the “NAAIM Exposure Index” (courtesy of Sentiment Trader), which has begun to show signs of rolling over…



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