The March edition of Bank of America Merrill Lynch’s monthly investor survey was released on Tuesday, and it revealed several things that I think can help investors going forward.
While I have been cautious about the post-Christmas rally and whether or not it could continue, the BAML survey showed that investment managers are also cautious. The survey was conducted between March 8 and March 14, and there were 239 panelists involved in the survey. The respondents manage $664 billion in assets.
The survey revealed that the appetite for risk continues to fall as suggested by global equity allocations falling to their lowest level since September 2016. The equity allocation has been falling for several months now, and it makes me wonder what is driving stocks higher.
The second item of note about the survey was that the respondents felt the “most crowded” trade were bearish bets against European stocks. It is the first time in history this scenario has been considered the most crowded trade.
European markets have faced a great deal of uncertainty over the past year with slowing growth in the region and Britain’s exit from the European Union, but investors may have been too pessimistic. Using the iShares MSCI Eurozone ETF (NYSE: EZU) as a barometer for the overall European market, European equities underperformed the S&P 500, but did beat China’s market in 2018.
Since Christmas, when global markets started to bounce back, the EZU has been in lock-step with the S&P. The S&P is up 14.8% and the EZU is up 13.4%. The Shanghai composite has led the way since Christmas with a gain of almost 24%.
The last thing we learned from the BAML survey is that the investment managers view the economic slowdown in China as the biggest risk. The slowdown supplanted the trade war between the U.S. and China as the biggest risk, and the trade war had topped the said list for nine straight months.
Recent progress in the negotiations between the U.S. and China are obviously impacting the responses. While there hasn’t been a deal announced yet, the negotiations seem to be moving in the right direction since the first of the year. At the same time, there have been additional economic reports showing that China’s economy continues to slow and the People’s Bank of China has taken steps to ease the slowing using monetary policy while the government is also taking action via fiscal policy.
What all of these developments tell me is that it looks like the rally from the last few months still has some legs to it with so much money on the sidelines. If major investment managers are lowering equity allocations and the market is still moving higher, that is a great sign that the market can continue higher for a while. The extreme pessimism toward European equities suggests that the region’s stocks may outperform other developed markets in the coming year.
Of course, I am taking a contrarian view here, and that view comes from almost 20 years of analyzing the market. Any time you have extreme optimism toward a stock or a market, I become cautious about it. Any time there is extreme pessimism, I tend to become more optimistic about the stock or the market. I should couch those last statements with one caveat—as long as the sentiment isn’t warranted based on the fundamentals.
Let me explain that caveat a little. If a company is seeing earnings decline quarter after quarter while sales are also declining, that is a situation where pessimism is warranted. If an economy is weakening or has entered a recession, pessimism toward the equities of that economy is likely warranted.
In the case of Europe, the economy has been slowing, but the region hasn’t entered into a recession. In this case, I think some of the pessimism was warranted, but not to the degree that we have seen in the past year. Once this pessimism starts to decline and some investors turn optimistic toward European equities, this will help drive stock prices higher.
My overall take is that we will likely see global stocks continue to rally for a little while longer. There is too much cash on the sidelines already for the markets to fall sharply, like they did in the fourth quarter. Because of the extreme pessimism toward Europe, I would expect the EZU to outperform the S&P for the next few quarters.