Fund Managers Are Very Greedy

Slight Increase In Stocks As Investors Await Fed Meeting

Thanks to the 0.25% rally in the final 40 minutes of Tuesday’s trading session, the S&P 500 closed up 0.26%. This put it about 20 points away from its record high. Nasdaq was up 0.4% and the Russell 2000 was down 0.4%. VIX fell 0.23 to 14.14 as the market hasn’t been volatile in September despite the historical weakness in this month. 

CNN fear and greed index fell 1 point to 66 which is still greed. The market is likely to soon make a new record high and be at extreme greed. This has been a greedy year for the S&P 500.

The Greed Should Be Worrisome

Greed in US stocks should be concerning to investors. The level of cash fund managers had in the Bank of America September survey fell to 4.7%. That’s down from the recent high of 5.7% in June. Managers are chasing the U.S. stock market specifically. 

As you can see from the chart below, allocation to US equities increased 15 points to a net 17% overweight which was the biggest monthly increase since June 2018. America is the most favored country by investors. You can tell by its outperformance. Allocation is 1.11 standard deviations above its long term average. 

Performance is terrible when this net percentage of managers are overweight US stocks. 27% of the time the net percentage of fund managers overweight US stocks is above 15%. When this occurs, annualized performance is -25.2%.

Tuesday’s Trading Action: Oil Falls

Tuesday was a reversal of Monday because oil fell, energy stocks fell, and the stock market rallied. Oil usually falls after big spikes. It’s a mean reversion after a kneejerk reaction to geopolitical events. Brent oil fell 6.5% and WTI fell 5.7% after Saudi Arabia stated it will restore production fully by the end of the month which was quicker than investors projected. 

A spike on Monday was a blip on the radar. It was way too soon to claim inflation would become a big issue because of oil prices. One day’s action is meaningless if the market returns to normalcy soon afterwards.

Speaking of returning to normalcy, the treasury market is regaining some of last week’s losses. As you can see from the chart below, August was the best month for long bonds since December 2008. Then to start September treasuries sold off viciously. It was the worst 10 days to start a month since at least 1987. 

Losses have been clawed back. 10 year bond is down 10 basis points from is recent high of 1.9% (to 1.8%). And the 2 year bond yield is down 8 basis points from its recent high of 1.8% (to 1.72%). Difference between the two is just 8 basis points. There’s no steepening here.

Recent declines in yields explains why the regional bank index fell 1.25% on Tuesday. Since oil cratered, it’s no surprise energy was the worst sector on the day as it fell 1.52%. Best 2 sectors were real estate and utilities which rose 1.4% and 0.89%.

The Fed Will Cut Rates

Fed will definitely cut rates on Wednesday even though the CME Group FedWatch tool shows there is a 54.2% chance of a cut. The tool has been impacted by the large selloff in the repo market. Important thing to realize is investors won’t be surprised by a rate cut. 

As of September 17th, the futures market was pricing in a 24 basis point decline in the Fed funds rate in September. There is expected be another 24 basis point decline by December as there will be either a cut in October or December. I expect the Fed to take some sort of action to control short rates. If investors feel the Fed has lost control of its main policy tool, stocks will react negatively. So far, stocks have completely ignored this issue.

FedEx Misses Guidance

After the weak Cass Freight index, it’s worth following FedEx’s earnings report to see how the economy is doing. Their earnings report was right in line with the past few months of Cass Freight readings. Adjusted earnings per share was $3.05 which missed estimates by 10 cents. Revenues were $17.05 billion which missed estimates by $10 million. 

The firm lowered its full year 2020 guidance to between $10 and $12. This weak guidance explains why the stock fell 9.94% after hours. If the decline holds, it will be down on the year. The firm blamed the weak macro environment for its weak guidance.

Amazon has begun competing with FedEx as it launched a Delivery Service Partners program which lets entrepreneurs run their own local delivery network of up to 40 vans. It also expanded its air fleet to 50 planes to rely less on FedEx and UPS. The quicker Amazon delivers packages, the more likely users will buy items. Also, quick delivery is a key feature of Amazon Prime.

Earnings Estimates Show A Decline In Q3

We’ve known for a while that Q3 would be the last weak earnings quarter for S&P 500 stocks as Q4 faces much easier comparisons. The biggest question is if the weak macro picture will prevent solid EPS growth in Q4. So far, so good as you can see from the table below. 

Estimates for Q4 earnings growth are 6.29%. I expect these estimates to fall modestly by the end of the year, but then they will be beaten when firms report. It’s possible the final result this spring will show about 6% growth. That would be solid compared to Q3 which could be the worst quarter of the year.

As the table shows, estimates are for a 1.4% decline in Q3. This surely means earnings growth will be modestly positive. However, even 4% EPS growth, which would be optimistic, is nowhere close to the S&P 500’s year to date gain of 19.9%. This type of gain will not be matched in 2020 unless EPS growth is in the high single digits. Even with great EPS growth, I expect a weaker year for stocks.

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