Yesterday we quoted from a surprising report by Credit Suisse, according to which after surveying numerous clients, the bank had come across "almost no one who seems to have outperformed or made decent returns this year." While not quite as extreme, the latest HSBC performance report confirms that the broader market is outperforming the vast majority of hedge funds in 2016.
But more surprising was Credit Suisse's admission that "we have never had so many client meetings starting with statements such as 'we are totally lost'." The main cited reason for the confusion is that "clients are close to being as bearish on equities as we can remember. Clients do not find equity valuations attractive enough to compensate for the macro, political, earnings and business model risks."
And yet, with everyone "bearish" the market continues to levitate higher to record highs (on ever less volume) most recently today, when it touched a new all time high shortly after the US reported the worst annual growth in GDP since 2010, further confusing traders who as we said yesterday, in a scramble for performance have succumbed to the oldest error in the book: performance paralysis, better known as a herd-chasing panic.
Today we got confirmation of just that, when in a report by BofA's Savita Subramanian, the strategist asks the following rhetorical question "if everyone is talking about how bearish everyone else is…"
Specifically, she takes on the Credit Suisse allegation of pervasive pessimism and further asks if "Is positioning really that bearish?" This is her answer:
Defensive positioning was likely a key driver of strong equity returns this year. While some indicators still suggest bearish sentiment – our Sell Side Indicator indicates that equity sentiment is at a 4-year low, and our Global FundManager Survey indicates that cash balances are near an all-time high – others suggest positioning has gotten more bullish.
Actually, instead of more bullish, perhaps a better term is "confused", because as BofA adds, active managers are now more exposed to beta than they have been since 2008.
In other words, instead of taking "active" advantage of stock dispersion and alpha generation, all the "smart money" is doing, is simply adding leverage to broader market surrogates, and doing what every other investor at home can do for free: ride the S&P500. The only issue is that "active managers" collect a fee for doing just that.
That said, it does appear that contrary to what they say, what investors actually do is something else, in the process turning the most long in one year, if only according to BofA:
"With the rally off of February’s lows driven largely by cyclical reflation plays, cyclical vs. defensive sector exposure is now the highest we have seen since 2012. Performance of equity long-short funds imply the highest net long position since July 2015 (Exhibit 1). See “Mixed signals from positioning metrics” inside for more details."
So how can one summarize this perplexing trifecta of "totally lost" investors, who are "as bearish on equities as we can remember", yet who are "the most long in one year"? Perhaps with a picture:
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Incidentally, not all investors are idiots, and realize just how little value said active managers provide, and have been voting with their money, pulling their cash out of active and into simple passive strategies.
As BofA notes, positioning has generated 16ppt of alpha YTD. As flows from active to passive funds have accelerated, one strategy that has worked unusually well for the last several years is a simple positioning trade of selling the 10 most overweight stocks and buying the 10 most underweight stocks by active managers.
In other words, our favorite trade of doing precisely the opposite of what the rest of the "smart money" is doing.
This single trade has yielded over 16ppt of alpha year-to-date. BofA adds, that "crowded stocks will continue to underperform neglected stocks: a significant two-thirds of US large cap AUM still resides in active funds. With a still challenging performance backdrop for active managers coupled with a fee-sensitive investor base, there is likely more to go in the rotation from active to passive (Chart 10). Crowded also stocks tend to get hit harder on bad news, and this earnings season is no exception: overweight stocks (>1.5x benchmark weight) that have missed on EPS and sales have underperformed by 1.4ppt on average the following day, double the underperformance of the rest of the group."
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Finally, some charts from BofA: