Fund managers hate US stocks – so when’s the bounce coming?

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US stocks are overvalued – but not in a bubble

I get lots of emails every day from investment banks, PRs, estate agencies, strategists, fund managers – you name it.

There are far too many to read. Even when you sift out the irrelevant stuff, there’s still not enough time in the day to read everything that might catch your interest. I’m sure it’s a problem a lot of you are familiar with.

However, there is one monthly survey that I always keep an eye out for.

And at the moment, it’s saying something very interesting about the UK.

It’s good to know what fund managers think – so you can do the opposite

The Bank of America Merrill Lynch global fund manager survey looks at how money managers are feeling about the investment world.

It comes out every month, and I like to keep a close eye on it. It’s not exactly a contrarian indicator (few such indicators are all that reliable, and you can rarely look at them that simplistically), but it does tend to be worth paying attention to anything that is particularly loved or hated at any given point.

Why’s that? At the end of the day, what moves prices is not news, or sentiment, or good or bad economic data, or even interest rates. It’s money flows. Prices rise when money flows into an asset class. They go down when the money flows out.

And if nothing else, the people who take part in these surveys are in charge of significant amounts of the money that moves global markets. If most of them are bullish on an asset class, it means there’s not much uncommitted money left to be channelled into it. On the other hand, if most of them hate an asset class, there’s plenty of scope for them to change their minds and buy.

For example, when they’re feeling jittery – lots of cash stored up – it has proved a good time to buy in the recent past. I’ve just looked back at the survey from February 2016. If you’ll remember, that was the climax of the China/Federal Reserve-inspired selling panic that hammered stocks at the start of last year. It was one of the best times to buy in the last 18 months.

At that point, fund managers’ average cash balances were at 5.6% – which doesn’t sound like much until you realise it was the highest cash holding since November 2001. So it was a good time to do the opposite of what the managers were doing, and turn bullish.

Thus the question is: what do fund managers think right now? And how could their expectations be thwarted?

The most hated country in Europe

First things first – if you’re a knee-jerk contrarian, then it’s good news for US stocks. The pros hate them right now. A net 83% of investors – the highest ever – think US stocks are overvalued. And they’ve followed through with their money – as a group, they are “underweight” US stocks by the most since January 2008.

Also, being bullish on the US dollar is still seen as the most crowded trade (in other words, managers think their colleagues are too bullish on the US currency).

Meanwhile, investors reckon both eurozone stocks and the euro are undervalued. Allocations to eurozone equities are their highest in 15 months. That’s despite the fact that EU disintegration is still seen as the biggest ‘tail risk’ (ie a thing that is unlikely to happen but would seriously affect markets if it did happen).

When I look at readings like that, it does get me thinking that the US might be due an imminent bounce back. US stocks are expensive, no doubt about it. But as Jeremy Grantham of GMO has pointed out, in the absence of euphoria (and there’s certainly not much of that about) it’s hard to argue that they’re in a bubble.

To be clear, that doesn’t make them particularly compelling and I have no desire to buy – I’m not especially interested in attempting to time a trading bounce. But there are plenty of other assets that look more overvalued. Bonds are one obvious one. And there are far more signs of irrational exuberance in other sectors (the boom in privately-funded tech companies for example – there’s a great story on Bloomberg about a high-tech juicer that has unmistakable echoes of Pets.com or WebVan).

The fact that managers are also waving away concerns about the eurozone, despite the looming reality of a critical French election that could really set the cat among the pigeons, also seems complacent. Again I’d favour eurozone stocks over the US on valuation grounds, but I’m under no illusions as to how bumpy a ride that could end up being this year.

What could reverse this situation? Firstly, US sentiment could be improved if we see some political progress in the US (a nudge towards tax reform getting done), or maybe some intervention from the central bank. Maybe the Fed will take its foot off the gas pedal, for example. Secondly, if Marine Le Pen does well on Sunday, that could really sour sentiment towards Europe.

So where does that leave investors? Well, there’s one country I haven’t mentioned. It’s in Europe, but no one likes it. It’s the UK. And interestingly enough, even before this survey came out, fund expert and regular MoneyWeek contributor Max King had already written a piece for us saying that he thinks it looks a great contrarian bet.

You can read all about why he thinks so – and get his tips on the funds best-placed to enjoy the UK bounce – in the latest issue of MoneyWeek magazine, out tomorrow. If you’re not already a  subscriber, sign up here.

A note on the French election and your holiday money

By the way, earlier this week, in my piece on the French election, I suggested holding off on buying your holiday euros until after the vote. I’d like to add a caveat to that because of two points.

Firstly, there is an outcome that would be good for the euro. It’s still most likely to be Macron vs Le Pen in the final round. That wouldn’t move markets much. There’s an outside chance it could be Mélenchon vs Le Pen. That would almost certainly hammer markets. But there’s also an outside chance that it could be Fillon vs Macron. That would probably lead to a relief rally and a stronger euro. So that’s a possibility to be aware of.

Secondly, we’ve just had the UK election announcement. That sent the pound a lot higher. People have gone back and forth on whether that’s due to hopes for a “softer” Brexit or not. For what it’s worth, I think It’s got nothing to do with Brexit. Investors clearly reckon that Theresa May is relatively competent (not hard, given the competition). Her main problem is her small majority. If she can get a bigger majority, that translates into more certainty, and markets like certainty.

Anyway, it means sterling is now almost as well-priced against the euro as it has been since the Brexit vote. So if you’re wary of a surprise upside outcome for the French election, you should maybe look at changing half now and half next week – not that I want to encourage amateur currency speculation.

Merryn

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