Via Peter Tchir of TF Market Advisors [12],
I’m back from the snow and am wondering where all the bears went? I cannot find more than one person willing to be outright bearish. What is particularly strange is that the reasons most people are bullish seem to have little, if anything to do with fundamentals – either macro or micro. The reason for being long that is closest to being “fundamental” is that Europe is muddling through. I’m not sure Europe is muddling through, but in any case, wasn’t the bullish case for US stocks that we were decoupling? Conspicuously absent as a reason to be long is earnings.
It seems as though everyone is reasonably long (though not fully committed), but thinks everyone else is underweight. It really feels like the “consensus” is that everyone else is underweight so you better be long for when that money comes into the market.
Where is this “money on the sidelines”? Maybe we get it. Maybe that flow comes, but from where?
Most hedge funds are now long. They can always get longer by deploying their remaining cash, or by leveraging up (becoming increasingly common in High Yield as the only way to generate 10% after fees is through leverage or buying real story credits). Hedge funds also always act as though they are fully leveraged, they have limited tolerance for losses and cut on any down move. To the extent they have caught most of this year’s rally they have room to buy on dips for now, but most funds seemed to miss some of the early strength and only got fully committed once SPX broke 1300, so they aren’t sitting on much of a cushion.
So hedge funds, can always get longer, but it seems as though they are all long and are extremely sensitive to returns as they attempt to grow AUM and the start of the year will be key.
What about retail? Won’t the fund flows reverse? There is a great deal of conviction that retail will reverse their trend of selling equities and actually start buying. Maybe the 1% doesn’t actually know anyone named “retail” but I don’t get a sense that anyone out there is going to be chasing returns. There are 3 key reasons that I don’t see this coming back any time soon.
Retail is sick of the market. Retail doesn’t trust the market and they are smart enough to know that it is being propped up by governments and central banks – they don’t know exactly how it is being propped up, but they know it is artificial and aren’t about to chase something that requires that much government support to stay up.
The traditional allocation model that Wall Street has peddled for years is flawed. The weighting for stocks was always too high (70% or 80% allocation recommendations were common) and what was considered investible money had little to do with savings (no focus that investible assets should have been assets minus debt).
Why would an investor go back to 70% or 80% in stocks? In terms of building a reasonable portfolio, bonds were always underweight. Part of the problem is the difficulty in managing a bond portfolio. Mutual funds were the primary way to get access to the bond market. While mutual funds remain a good way for retail to invest in bonds, the credit ETF’s have made it far easier for investors to allocate money to fixed income. It seems like there are about 20 people pitching “dividend champions” for every person pitching high yield which is just too high. Yes, the dividend stocks have more upside, but they also have more downside. Not only can the dividend change, but the equity is subordinated to debt. Stocks (including dividend stocks) have a place in any portfolio, but bonds do too. Bonds provide a stream of income at a senior level of the capital structure. Whether the allocation should be more towards sovereign debt, investment grade, or high yield, will change over time, but I believe the allocation to fixed income products is permanent. It isn’t just performance chasing, or risk aversion, it is smarter diversification (at least for investors ). After the experience of QE and non-stop talk about money printing, commodities have earned a place in investor’s portfolios. Again, the mix will change between hard and soft commodities and precious metals, but the reality is these belong in investor’s portfolios and I don’t see the allocation returning to where it was (basically 0). So the asset allocation has changed, but in spite of all the crying that investors are fleeing stocks, and will regret it, I suspect that the allocation model of smaller portion in equity with meaningful, permanent allocations to fixed income, and to a less extent commodities, is here to stay as it actually makes sense.
The other change is that small investors are fully aware of the pain of debt. A couple of years ago, someone with $50,000 in “savings” and $20,000 in credit card debt would put 80% of the 50k into stocks. Why was their “investible” savings ever considered 50k and not 30k? Who knows, but investors are much more aware of their debt obligations and are either paying that down or keeping much more cash on hand than in the past so they can weather any storm. Again, this makes perfect sense to me and is how it should have been all along. I don’t see people ignoring debt obligations any time soon, so what people consider “investible” assets has decreased.
I think it is taking time for this allocation process to play out. There will be swings in both directions, but there has been a long term shift in what investors consider assets that can be invested, and how those assets will be invested. Retail investors may pile back into stocks, but they will likely want to see real signs of sustainable growth and not feel like they are being pushed into some artificially manipulated game they can’t understand or can’t win at.
Finally there is all this cash on corporation’s balance sheets. Balance sheet repair and record amounts of cash on corporate balance sheets are a constant refrain. My concern with this argument is that the cash is not evenly distributed. A large portion of the cash is sitting on the balance sheets of large cap tech companies. Figuring out how they will use it is important, but at the same time, pretending the cash is available across all industries is wrong. It is also worth noting that companies like MSFT have been issuing bonds steadily since 2008 and even Google decided to borrow money. Net cash isn’t as strong a story as cash, and the fact that the cash is relatively concentrated in a few companies, and in many cases offshore, makes the potential for this money to help the broad market less likely than may already be built in.
The other consensus trade had been that the US would decouple from Europe. Back on December 15th we first wrote that everyone seemed to be bullish the US and bearish Europe and wondered if it wasn’t time to Go Long Europe, Short US? [13]
Since then the trade has been up and down but is currently up by 2.5% to 3% depending on whether you took currency risk. Not a great performer, but on the other hand given how convinced everyone seemed that the US would outperform it is worth paying attention to, especially as everyone now seems to be getting long.
[14]
Will the real bear please stand up? If you look around your trading floor and ask anyone who isn’t at least 50% long to stand up I think you will see a lot of people remain seated, wondering why more people aren’t standing up. The conversations are far more bearish than the positioning.