Implications of Surging Momentum and Highlights of BoAML Fund Manager Survey

by the Curmudgeon

Despite valuations and sentiment indicators off the charts, the U.S. stock market has shown astounding relative strength this year with the DJI average easily surpassing 26,000 in morning trading today. The reversal to a slight daily decline in all the major averages is insignificant, when compared to the momentum surge during the first nine trading days of 2018.

Leuthold Weeden’s preferred measure of “medium-term momentum” (14-Week Relative Strength Index, or RSI) blasted to a new high for the current bull market (which started in March 2009). According to one Twitter pundit, the S&P 500 RSI was the strongest since at least 1929, which was before RSI was even calculated!

“That’s extraordinary, and yet another piece of evidence that the bull is not quite ready to meet the mortician,” said Doug Ramsey of Leuthold Weeden.

It’s historically been very rare that the cyclical peak in stock prices coincides with the peak in momentum. The table below summarizes market behavior leading into the last 21 cyclical bull market peaks dating back to 1900. (Leuthold used weekly closing prices to define those cycles since their momentum measure is also weekly). Among these cases, the peak in market prices coincided with the bull market’s momentum peak only two times (in 1938 and 1980). In more than 90% of past cycles, a fresh cycle peak in momentum was a pre-cursor to many more months of market gains.

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Chart of S&P 500 vs Medium Term Momentum (14-week RSI):

Source: The Leuthold Group

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Curmudgeon Comment:

Indeed, the Curmudgeon vividly remembers the super strong stock market in the first two weeks of 1987, with the peak for most stock averages occurring in late August of that year – prior to the October 19^th crash. ………………………………………………..

Once a bull market peak in momentum has been established (which obviously can be known only with hindsight), the average additional gain in the market has been +18.4%, occurring over an average span of 60 weeks.

The implication is obvious (and painful to value investors and seasoned veterans who’ve experienced many long grinding bear markets): RSI and momentum this strong usually requires a multi-month cooling-off phase before the bull market becomes vulnerable to a severe correction, bear market, or crash.

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The following is from a BofA Merrill Lynch Global Research report (bold font added where deemed appropriate):

January 2018 BoA ML Fund Manager Survey finds equities the asset of choice for investors (no surprise!)

Average cash balance falls from 4.7% in December to 4.4% this month, a five-year low.
Allocation to equities jumps to two-year highs of net 55% overweight, while allocation to bonds falls to four-year lows of net 67% underweight; investors are the most overweight equities relative to government bonds since August 2014.
The balance of investors indicating they are taking out protection against a near-term correction in the markets falls to net -50%, the lowest level since 2013.
Investors are split on expected timing of equity markets peaking; “2019 or beyond” was the most commonly cited response (30%).
Net hedge fund equity market exposure climbs nine percentage points to net 49%, the highest level since 2006.
The net share of investors saying global corporate earnings will rise 10% or more over the next year comes in at net 15%, the highest level since 2011; furthermore, 57% of investors would like to see companies increase capital spending.
Short Volatility (28%) for the first time overtook Long FAANG+BAT (26%) and Long Bitcoin (24%) as the trade considered most crowded.
Inflation and/or crash in global bond markets (36%) tops the list of tail risks cited by investors; the top three are rounded out by a policy mistake by the Fed/ECB (19%) and market structure (11%).
Net 11% of investors surveyed expect the U.S. yield curve to flatten in 2018, the highest level in over two years.
When asked about preferred regions, global investors say they would most like to overweight Eurozone, EM and Japan; the UK continues to be deeply out of consensus, falling once more to a new record low since 2001.
Investors rotate into cyclical plays: tech (the largest monthly rise since July 2014), industrials, EM and equities; they moved out of defensive plays like telecom (second lowest level since 2005), bonds, utilities, and the UK.

Total Return of Global Equities/Global Govt Bonds vs Fed Funds:

Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg

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“Investors continue to favor equities,” said Michael Hartnett, chief investment strategist. “By the end of Q1, we expect peak positioning to combine with peak profits and policy to create a spike in volatility.”

In summary, BoAML finds that Investors are long stocks, unprotected from a correction or bear market, and believe the global equity bull market will continue to “2019 and beyond.” If those pros are correct, bears are in for a lot more suffering!

Good luck and till next time...

The Curmudgeon
ajwdct@gmail.com

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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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