Before we get started this morning, I wanted to let you know about an upcoming online interview that I think you’ll almost certainly not want to miss. Our own Merryn Somerset Webb will be talking to Baillie Gifford’s Charles Plowden next Thursday (28 January).
Baillie Gifford, as I suspect most of you know, has been among the most successful investment managers of this particular era, helped by canny investments in the superstar companies of the past decade such as Tesla, Softbank and the FANGs.
What’s their secret? Can it continue? And what does the post-pandemic era hold for investors? Don’t miss it. Register here to view it live – it’s free.
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Back to this morning’s email – it’s time to turn to how the world’s biggest money managers are feeling about life right now...
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Why big money managers’ views matter
I find the monthly Bank of America survey of global fund managers one of the most useful sentiment indicators to monitor. Over the long term (sometimes the very, very long term), the price of assets in markets should basically converge with their “real world” value. That’s the whole point of markets – they’re the best way we know of pricing things in the face of uncertainty. You take the opinions of as many people as possible, add them all up, and the average gives you a pretty good estimate of reality. That’s the “wisdom of crowds” in action.
The classic example is of a “guess the cow’s weight” competition, or a “how many jelly beans are in the jar?” contest. The individual guesses may be well out, but if you average all the guesses, they’ll be astonishingly close to the right answer.
But that doesn’t always happen. We are only human. We tend to extrapolate – we think in trends. And markets are reflexive – in other words, people look at what the market is already doing, and incorporate that into their own views. So the market itself, which is meant to be a measure of people’s opinions about the “real world”, influences those opinions.
In turn, that means not everyone’s opinion is independent. A lot of us are basing our views on what other people are doing. That, combined with our weakness for extrapolation, means that market moves can often end up being exaggerated.
This is where sentiment and fund flows come in. When you see a majority of new money being channelled into one particular area of markets and opinions (backed by money) converging, that’s the closest you can probably get to decent evidence that the market is in danger of getting seriously out of touch with reality. And the more stretched sentiment and flows become, the harder the snap back when the bubble bursts. After all, once all the money in the market is investing in one opportunity – if everyone is a buyer – the only way is down.
This is why the global fund manager survey is useful. It gives us as good an idea as we can get of where the people whose opinions matter most – the ones with the most money behind their views – are actually putting that money. So where are they putting it now, as we enter 2021? And what are they avoiding?
Everyone is strikingly bullish on the same things
Long story short, big investors are very bullish. Faith in the “reflation” trade is high. Most investors expect corporate earnings to improve over the next 12 months. That seems sensible – it’s not as though the last 12 months were amazing for earnings.
More concerning – for any contrarians – is that inflation expectations are at an all-time high (the survey goes back to the mid-1990s). It’s not that inflation doesn’t seem likely to me too – the concern is that if there is such a consensus around it, then chances are it’s already being heavily priced into the market.
That’s reflected in the sorts of shifts we’ve seen in recent months. The weak dollar, higher inflation trade has been accompanied by the idea that overseas assets will “catch up” with US markets. As a result, a lot of managers have been betting on emerging markets (EM). According to the BoA survey, a record proportion of managers are now “overweight EM”, with two thirds of them reckoning emerging markets will be the top performing markets in 2021.
Meanwhile, managers moved into “reflation” trades like banks, energy and commodities in a big way this month, and dropped their allocations to tech. They’ve also become less keen on “boring” defensive plays like consumer staples and utilities. Optimism on stocks overall is in the “extremely bullish” category. Even sentiment on the UK has started to turn around, although it is still the most detested region in the world, which at least bodes well for longer-term contrarian punts on Britain.
It’s all pretty clear – if big investors aren’t at “peak” bullishness, then they’re not far off it. A record percentage of fund managers say that they’re taking higher than normal risks.
But the most obvious indicator that we’re at risk of a correction imminently is the state of fund managers’ cash piles. They don’t have much at all. Cash in funds is sitting at 3.9%, which is the lowest level since March 2013. It’s so simple that it seems facile – but if most cash is already in the market, then that means there’s not much more buying to be done.
Does that mean you should sell? Not at all. That’s not how you invest for the long term. But I wouldn’t be surprised to see a bit of a correction in the markets, driven by investors getting a bit disappointed that their "reflation” trades aren’t working out as quickly as they’d expected them to.
Markets are forward-looking, but they’re also impatient. And if they don’t get constant affirmation that their view is right (ie, some higher inflation readings, and a sign that vaccines really are shutting Covid down and allowing the economy to open up) then they’ll get fractious and run out of steam.
There are plenty of opportunities over the coming weeks and months for minor disappointments to hit. The recovery from Covid will take a bit longer than hoped; inflation will return in fits and starts, specific to various sectors, before it becomes widespread; in the US, Congress might take longer to hammer out all the exciting spending packages investors are expecting. Meanwhile, the Federal Reserve might be reluctant to tackle the issue of gently rising long-term interest rates until the market throws a tantrum and forces its hand.
None of this means that reflation isn’t going to happen. Or that we’re on the verge of a longer bear market. But if markets have jumped the gun and got over-excited, then it won’t take much at all to put a dent in their confidence, and that could result in a decent-sized correction.
So brush up on your watchlist of assets you’d like to buy if they were a bit cheaper, and just be aware that it might happen in the next few months, and don’t panic if it does.
Oh, and on a side note – one interesting shift is in what’s viewed as the “most crowded trade”. In recent months, “long tech” and “short US dollar” have come up as the key things that fund managers believe everyone else is betting too heavily on. What’s top this month? “Long bitcoin”. That might help to explain why the cryptocurrency has had a tougher time in the last few weeks.
