Investors Are Very Overweight Cash

Stocks Rally On Tuesday

This week is shaping up well as the S&P 500 increased 1.07% on Tuesday, meaning it is 3.75% off the February 8th low. I still think the recent high of 2,787 is important. The S&P 500 is now 81 points away from that mark. The earnings season looks like it may actually be a catalyst for stocks to move up. The narrative in the past few weeks has been that earnings were going to push stocks up. Usually the narrative is biased to the upside and it’s often wrong, but that one looks like it will be accurate. Some bearish investors claim the growth in earnings doesn’t count because it’s coming from the tax cuts. I disagree strongly. The growth rate is unsustainable, but the earnings are real. The time to worry about 2019 earnings growth will be later in the year as the first quarter earnings period isn’t even 10% done with. I do think 2019 will be a rough year for stocks, but that bearishness doesn’t matter if stocks are down 10% from their all-time high in 2018. That will be an important topic if stocks break a new record. At that point, I would turn bearish.

No Reason To Fear A Bear Market

Every sector was green except the financials which were down 0.07%. The consumer discretionary sector was helped by Netflix as it was up 1.87%. The big catalyst for stocks in the next few days will be the rest of FAANG’s earnings. It’s funny to see the VIX falling 7.91% to 15.25 just after there were articles claiming the VIX was the new safe haven. That was clearly ridiculous as this is likely a normal, albeit elongated correction. The European economy is weakening and the U.S. consumer is stagnant, but there’s nothing that suggests a bear market is coming. The chart below shows the recent global PMI weakness in both services and manufacturing. If that was enough to cause a bear market, we would’ve had many in the past 10 years. It’s even too early to say this is the 3rd global slowdown since 2010.

Yield Curve Flattening Substantially

Even though stocks had a good two days, the yield curve has been flattening which further increases the odds that there is a recession in 2019. We are getting closer to the summer which is when I’ve said is the earliest the inversion will occur. The 2 year yield continues to increase as it’s at 2.4% while the 10 year stays stagnant at 2.84%. The 10 year yield’s inability to increase because of the economic slowdown is causing the curve to flatten almost everyday as the latest difference is only 44 basis points.

The Fed keeps getting asked about this because this is the top story in finance for 2018. Williams stated the curve wasn’t near an inversion. He said if an inversion were to occur, it would be a problem. The Fed appears to be in denial as 4 hikes in 2018 would most likely invert the curve. It would be very easy to state there is no possibility of 4 hikes, but for some reason the Fed is worried about inflation even though the core PCE is at 1.6%. It’s disconcerting to see that the Fed funds rate is almost exactly at the core PCE, yet the yield curve is getting ready to warn about a recession. The Fed wasn’t allowed to raise rates much this cycle.

Investors Were Shaken Out

There were more buying opportunities in this correction than a usual one as stocks were in a steady range for more than 2 months. I have been very bullish on short term performance as downside risk is limited. The chart below shows many investors disagreed with me in April as the net allocation to equities fell to an 18 month low of 29% from a net 41% in March. Allocation is at its long term average. The hope if you want stocks to hit a new record is that sentiment becomes more optimistic and the buybacks help performance after the blackout period ends after earnings season. Optimism isn’t going to just magically return. There needs to be improvement in the economic data which we’re not seeing yet.

The chart below shows an alternate viewpoint of a similar situation. Cash actually did better than most of the major asset classes in Q1 which is unusual. As you can see, investors piled on that trade by raising cash in April. This could be a good sign for equities and long term bonds since such high z-scores usually aren’t sustainable. Like I said, there needs to be a rebound in Q2 after a weak Q1. I don’t think the Q1 GDP report will act as a catalyst for stocks to move lower, but it will tell us what we already know: Q1 wasn’t a good quarter for the economy.

Interestingly, the banks were also overbought in this survey. That could explain why the big 4 banks sold off after their good earnings reports. It’s also interesting to see the Eurozone was overbought despite the weak economic reports there. I think some people bought into the notion that American stocks were expensive based on the CAPE, so European stocks were a good respite for high valuations. The earnings segment of the CAPE will be getting a big boost in the next 12 months. American stocks aren’t expensive if you believe the forward PE which implies no recession is coming.


The cash position in fund managers’ accounts was high at the bottom of this recent range. Stocks are only up 3.75% from the bottom, so there’s still room to run. When stocks are down, you ask the question what can push stocks up. When stocks are up, you ask what can push them down. The economic data prevents stocks from making an all-time high and earnings are preventing a bear market. The economic data will improve in the next few months which makes me bullish on stocks for the rest of the year.

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