Fund Managers Overweight Emerging Markets & Underweight U.S. Stocks

Fund Manager’s Survey

We’ve looked at some of the results from the BAML fund manager’s survey in a previous article. Let’s look at some more results to help us forecast where asset prices are going. The chart below shows the z scores of a few assets. When the z score is high, it is overbought and when the z score is low, it’s oversold. As you can see, the banks have a z score near 2 which shows us that they will likely sell off in the coming weeks. I’m guessing this survey was done a couple weeks ago because there was a selloff in the first week of November in the KRE regional bank index as it fell 6.05% from its late October high. In the past few days it has increased, so now it’s down 3.8% from the high. Therefore, in the short term it makes sense to avoid them based on this data. Equities have a z score of below 1 which is surprisingly given the massive global rally. The U.K is extremely oversold, which could mean it could be in for a quick bounce back.

One of the reasons the bank stocks are rallying so much is because of the net interest income they are earning. Net interest margins increase when the Fed raises rates. The Fed is about to raise rates 3 times this year which is a big boost to their bottom lines. The chart below shows the percent change in net interest income. Since rates were so low last year, the percent change is about 8% higher. I’m expecting another 2 hikes in 2018. The fact that banks are rallying might be because the consensus on rate hikes is increasing to 3 or 4.

The chart below paints a more bearish picture of global equities as the light blue bars show the November allocation increased to 49% overweight. As you can see from the black dotted line, there has been very few times when the fund managers had a higher allocation to stocks. This is a ceiling for stocks that they will have a tough time breaking through. This isn’t shocking as it’s tough to repeat a year where almost every country saw its stock market rise. The black line is the most disconcerting. It shows the global equity performance compared to the generic basket which holds 60% stocks, 30% bonds, and 10% cash. Fund managers are very underweight bonds and very overweight stocks. This could mean a sharp selloff in stocks is coming soon.

If that chart caused concern for U.S. stocks, you can rest assured because recently fund managers are extremely underweight U.S. stocks. That’s surprising because of how well American stocks have done this year. However, even as fund managers have been underweight U.S. stocks for the past few months, U.S. equities have outperformed global stocks in the past few years. The U.S. market has the exact opposite stats of emerging markets. Emerging market stocks have underperformed global stocks in the past few years, but fund managers have been overweight them for the past few months. There could be a quick correction in emerging markets in the next few weeks, but I think they deserve the attention they are getting because their economies have been improving this year.

The final chart from the BAML fund managers’ survey which we will review shows expectations for long term interest rates. As you can see, the majority of fund managers expect long run interest rates to go up. This goes hand in hand with managers being underweight bonds for most of the past 20 years. They have been wrong as bonds have been in a 34 year bull market. As we discussed previously, when real rates reverse from mini depressive episodes, they have sharp increases in the following 24 months.

Global Economic Growth Stats

In a previous article, I showed a Deutsch Bank chart which showed next year will have the lowest number of countries in a recession. That explains the global equity outperformance over the 60-30-10 portfolio. The chart below shows an alternative chart with the same type of results. As you can see, the chart shows how many of the top 45 OECD economies are contracting, have slowing growth, or accelerating growth. For the first time since the financial crisis, in 2017 there were no countries which were in contraction. There were only 12 countries with slowing growth. There were the most countries with accelerating growth since 2010. Next year, there is expected to be an increase in the number of countries with slowing growth to 19. 2017 and 2018 look a lot like 2006 and 2007. Hopefully, 2019 isn’t similar to 2008. Looking at the yield curve, in late 2006 the yield curve was already inverted which implies that a recession might not come as fast as 2019.

Despite the increase in the number of countries expected to see their growth slowing, the median expectations for 2018 world GDP growth has increased from 3.4% at the start of the year to above 3.6%. You can clearly see how the expectations are manipulated by current results. The expectations fell in 2015 and in the first half of 2016 because the economy was weak. Ever since it started improving in the second half of 2016, the expectations have moved up. Clearly, recent performance doesn’t indicate future results because we have seen slow and fast patches within the past 3 years. Therefore, the forecasts aren’t accurate. That being said, I do expect emerging markets to have a strong 2018 as the global economic recovery gets underway. There have been 2 mini soft patches in this expansion period. The recession question will pop up once again when there’s a soft patch in 2019 or 2020. As for now, global growth looks good.


Generally, it makes sense to fade what every fund manager is doing. However, sentiment can change after small price changes. Even though fund managers are very bullish on emerging markets, I still think 2018 will be a strong year for them.

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