Bank of America Merrill Lynch released its monthly Global Fund Manager survey on Tuesday and the results showed a huge shift in asset allocations. The allocation to bonds jumped by 23 percentage points and that is the biggest one-month rotation ever. The survey also showed that the equity allocations dropped by 15 percentage points.
Given the way equity markets have behaved in recent months, seeing money managers shift assets out of stocks shouldn’t be a big surprise. Seeing them shift at such a dramatic level is surprising. Perhaps a number of managers learned to be more proactive about allocation changes after the bear markets of 2000-2002 and 2007-2009.
In the first two bear markets of the 21st Century, there weren’t many money managers that really knew how to deal with a prolonged move lower. In the 80s and 90s, there were only really brief periods of selling and perhaps this led money managers to react slowly with their asset allocations. Sure there was the crash in ’87, and that did count as a bear market, but the drop happened in one day and the market recovered all of its losses pretty quickly as well. Take a look at the chart from First Trust below.
From 1974 through 2000, the ’87 crash is the only bear market as defined by their criteria. And in case you are wondering, here is the definition they used to mark the periods on the chart:
“From when the index closes at least 20% down from its previous high close, through the lowest close reached after it has fallen 20% or more.”
The S&P dropped almost 14% from its high in September to the low on Monday. Using the 20% rule to define a bear market, the S&P reached a high of 2940.91 in September and that means it would need to drop to 2352.73 to be called a bear market.
Regardless of whether we end up seeing the S&P fall into bearish territory by this definition, seeing money managers shift their allocations at this point could be a good sign for stocks.
One of the things that can prolong a downswing in the market is a reluctance by investors to let go of stocks. The selling goes on and on until a capitulation point is reached and all of those that wish to sell have done so. The sooner we reach a capitulation point, the sooner the downswing ends. Seeing such a dramatic shift in asset allocation so early in the downswing will likely help the market reach a bottom sooner.
Personally, I was looking at various bond ETFs to see how they were moving and also checking the trading volumes on the funds. Bond ETFs weren’t around in the bear market of 2000, but they were in 2007. Unfortunately, the bear market of 2007 started due problems in the credit markets, so that isn’t a very good one to look at for comparison purposes.
Despite the flaws with bond ETF history, I did take note of several developments on the funds. The iShares 20+ Year Treasury Bond ETF (Nasdaq: TLT) has jumped over 6% since a low on November 2 and that is what I expected with investors fleeing equities and looking for safety, but I was surprised that the volume hasn’t been increasing in the past 10 weeks or so.
I also looked at the iShares iBoxx Investment Grade Corporate Bond ETF (NYSE: LQD) to see how its price and volume had changed in the past few months. My observation here was that the volume started increasing at the beginning of October, but the price didn’t start increasing until the beginning of December. At this point the price is only up 1.57% from the low at the end of November.
In order to be thorough, I looked at a third bond ETF. The iShares Core U.S. Aggregate Bond ETF (NYSE: AGG) attempts to model the Bloomberg Barclays U.S. Aggregate Bond Index. The index measures the performance of the total U.S. investment-grade bond market. The AGG started rising toward the beginning of November and is up 1.6% since then. Like we saw with the LQD, the volume has increased in the last few months.
Making these observations on the bond ETFs does in fact match up with what the Bank of America Merrill Lynch survey shows. The prices are increasing as investors move into the funds and the volume on the LQD and AGG are both increasing.
I don’t think we have seen a big enough move yet to declare with certainty that we have reached a bottom in the stock market, but I would say these are positive signs. There are still too many factors that could keep the selling pressure on the market for months to come—the trade war, the Fed’s interest rate path, possible government shutdowns, etc.
If the stock market does continue to fall, the more we see asset allocation changes in the coming months will help judge when a market bottom may have been reached. The more money shifting out of stocks and into bonds the better we will be. The shift will shorten the duration of the downswing.