What a difference a few months makes for asset allocators and top down portfolio strategies! Last summer the world was convinced there was only one asset class to own, Bonds! In July’16, a Bond investor was paying the equivalent of 0.5% to Germany for holding their money for five years! By August 2016, around two-thirds of the broader Bond markets was in negative yielding territory. In October’16, the Italian government issued its first sale of ultra-long bonds at a yield of 2.8% generating 18.5 billion Euros worth of orders on a 5 billion Euro sale as investors shrugged off political uncertainty and a troubled banking system only in search of any positive yield available in the market as investors desperately shrieked “TINA” (there is no alternative).
Most believe that Trumponomics was responsible for the aggressive shift out of Bonds into Equities in November 2016. At the inauguration speech, President Trump’s use of adjectives such as “phenomenal”, “fantastic”, “big big cuts” to describe future policy under his reign did manage to rally up the troops as they all piled into Equities on an expected stimulus boost to growth. But the shift out of Bonds into Equities (the “unwind”) started much earlier; in September’16 when the Fed treaded on a slightly more hawkish path as US economic data was on a more solid footing and exogenous risks had abated. Take extreme long positioning and huge amounts of leverage, throw in a pebble into that stream of complacency, what do you get? Massive exodus!
Over the last month the so called “reflation” trade is being called into question as Bonds have rallied recently from their lows, Miners and Energy names pulled back, and Gold nudging higher as real yields fall once more. One can argue the excess short Bond positioning is causing some unwind, or perhaps a reality check. The million dollar question: Are Equities really a short here?
Trump’s promised tax cuts are certainly positive for Equities as an asset class, but one needs to ask whether this is now more than priced in by the market? The forward 12-month P/E ratio for the S&P 500 stands at 17.6x, highest since 2004 and above the four most recent historical averages. Global CPI’s and PMI’s are improving and economic data is on a more solid footing across the board as seen by latest string of data. How much is artificial (futures based) vs. real (activity based) remains to be seen. If one were to study the S&P trading activity, there is usually a volume spurt towards the last 15 minutes of the trading day, which implies program baskets from retail/passive funds rushing in to buy the market. Recent cash holdings held in Mutual Funds show levels are down to a five year low. Retail investors who missed the rally of Q4’16 are being forced to chase the market higher on promise of higher returns. Investor sentiment as seen by the AAII Sentiment Survey shows the percentage of bulls at an extreme vs. percentage of bears currently.
Investing is all about risk reward, sometimes its best to capitalise on the profits and sit on the sidelines awaiting a better entry point. Truth be told, there is a lot happening underneath the surface that needs to be examined than just focus on the top down Bonds vs. Equity moves. Sector and stock correlations have been falling; maybe 2017 is a year when active fund management comes back into vogue, what do you think Warren?
