Thursday, October 24, 2013

A time for caution

I wrote that my inner trader was turning more cautious after getting long to await the post-government shutdown/debt ceiling relief rally (see Time for a market pause?) and my tactical position remains unchanged.

We are seeing further confirmation of frothy markets and a crowded long reading - which of which suggest that there is an accident waiting to happen. As always, Bespoke ably pointed out the latest AAII sentiment readings shows a condition represented by too many bulls and too few bears:

As well, froth is coming back to equity markets. The New York magazine featured an article entitled The Age of Bullshit Investments Is Back! Junky More speculative investment ideas are gaining traction once again:
Look around today's markets and you'll see a surfeit of senseless investment opportunities wearing the cloak of legitimacy.

You'll see, on page one of the New York Times, a start-up called Fantex touting a new investment vehicle that allows fans of NFL running back Arian Foster to support his career by purchasing stock that gives them a share of his future earnings. (What didn't make page one: Foster's career-worst game the very next Sunday.) This investment opportunity, which will appeal mainly to those too young to remember Bowie Bonds, is a terrible idea on multiple fronts: It bases returns on the unpredictable performance of professional athletes, it gives stock that can only be traded on a private, relatively illiquid exchange, and its single-athlete stock can be converted into common Fantex stock whenever the company feels like it.

Look harder, and you'll see companies like Goldman Sachs throwing millions of dollars at hare-brained schemes like Motif Investing, a "theme-based stock investment platform" that allows rank amateurs to make up "motifs" of stocks they think are going to behave in a certain, coordinated way. (Professional stock traders do this all the time, without calling it a "motif" strategy — but they don't charge ordinary people what can amount to double-digit fees, nor do they base their investment decisions on "Companies with lots of Facebook likes," as Motif suggests.)

You'll see Bitcoins, the everlasting fascination of Silicon Valley crypto-geeks, being not only spoken about as an investment-grade commodity despite having higher volatility than your average Baldwin brother, but inspiring entire investment vehicles (one of which is structured by celebrity twins) that give ordinary investors as well as the tech-savvy crowd the chance to lose money when the fad runs its course. You'll also see art dealers trying to convince you that betting on the paintings of unknown artists is a sound portfolio move.
I could go on, but you get the idea. The dumb money is now chasing the risk trade.

Bearish catalysts
These conditions suggest that markets are vulnerable to a pullback, but without a bearish catalyst, markets can continue to grind higher.

The bearish catalyst may be in seen in the form of institutional money flows. Institutions move glacially and once their fund flows start to move in one direction, the trend doesn't reverse itself easily. Kevin Marder, writing at Marketwatch, recently detected signs of institutional selling:
Like an elephant getting in or out of a bathtub, their buying and selling is there for all to see. Despite prices holding up near their highs in many cases, there is net selling taking place in the liquid glamours, as well as in some of the tertiary leaders.

While this began a few weeks ago in some cases, Tuesday it was seen in a number of stocks, including , Facebook and LinkedIn, name just a few.

Notably, this selling occurred on a day in which the Nasdaq Composite was up. Others not listed above were distributed on Monday or Wednesday.

Perhaps the truest sign of institutional sentiment are the liquid glamours, those titles that are gifted with rapid earnings growth and also deep liquidity. Institutions can never own enough of these simply because liquid glamours do not grow on trees. Large investors, such as mutual funds and pension funds, often overweight these names in their portfolios as a means of differentiating their performance from those of their peers and their benchmark, e.g. the SP 500.
My own long-term risk-on/risk-off fund flows model flashed a sell signal on Friday, indicating a the start of sustained selling pressure. Indeed, the BoAML fund manager survey confirmed that institutional investors continue to scale back their US equity holdings, though they remain overweight (via Marketwatch):
Asset allocators have scaled back their equity holdings. A net 49 percent of global asset allocators are overweight equities, down from a net 60 percent in September. Over the past month, investors have reduced their positions in eight out of the 11 sectors monitored by the survey. Last month, a net 9 percent of the panel remained overweight U.S. equities, and this month, that measure has dropped to zero percent. At the same time, investors have shifted back towards fixed income, scaling back their underweight positions in bonds and portfolio cash levels rose.

So putting it all together, we have excessive bullishness and froth back in the markets, combined with institutional selling in US equities. What's more, results from Earnings Season has been so-so. Bespoke reports that corporate guidance has been weak:

What more do you need to know? This is a time for caution. Don't try to be a hero.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.


rp1 said...

Having utterly failed to reform the system in any way, what if the average person rationally decided to blow it up? Drive the P/E over 100.

WimpyInvestor said...

A few other signs of retail optimism.

1. Wealthfront AUM $400MM from Silicon Valley new money.

2. Betterment proudly announced that most customers have 80%-90% equity allocations -- celebrating success this year.

3. New Financial Tech (FinTech) start-ups raising significant VC money -- SigFig, FutureAdvisor, RebalanceIRA / MarketRider, Jemstep, Financial Guard, Personal Capital, Quantopian, Covestor, etc.

ElementalEntity said...

I expect a small correction, especially to the US market. That's based on the falling IWM:VV ratio (small caps to large caps). However, it would be a surprise to me if this were to be a mini-bear (e.g. as large as summer 2011), because financials and discretionaries (XLF and XLY) are still strong.