Stocks are hitting all-time highs and greed is taking hold, with fear of missing out on further gains now driving markets. That's the key takeaway from Bank of America Merrill Lynch's latest fund manager survey. Allocations to global equities have hit their highest level in a year. Investor cash levels fell from 5 to 4.2 per cent in November, the biggest monthly drop since November 2016 and the lowest cash balance in six years.
Recession concerns have vanished; the number of managers expecting a stronger global economy over the next year surged 43 percentage points, more than the biggest monthly jump on record. It’s important to remember the survey is a contrarian indicator; excessively bearish sentiment tends to be a buying opportunity, while excessive bullishness can be a warning sign. Muted sentiment in recent months has represented a tailwind for global stocks. However, while that tailwind is gone, sentiment is not yet a headwind.
The survey data shows that while equity allocations are at their highest levels in a year, they remain slightly below historic norms. Bank of America Merrill Lynch's Bull & Bear indicator generates a sell signal at a reading of 8.0, but the latest reading (3.8) is nowhere near that level. In other words, there's no excess greed just yet. The "easy part" of the rally is over, says Michael Hartnett from Bank of America Merrill Lynch's Bull & Bear, but stocks still have room to keep rising.
A late-cycle rally?
The fact investors are getting bullish at the current juncture might seem like a worrying indicator that this is a very late-cycle rally. After all, stocks have hit multiple all-time highs lately and the bull market is more than a decade old; might that imply we are witnessing the dying days of this long bull run? Not necessarily. This is arguably the longest bull market in history (arguably, because you can play with the statistics a little), but it's not the strongest. The S&P 500's 357 per cent gain since March 2009 remains shy of the 417 per cent gain recorded during the 1990s, notes LPL Research's Ryan Detrick.
Stocks have averaged annualised gains of 15.3 per cent during this bull market, he adds, which is actually weaker than the average bull market (18.9 per cent). As for all-time highs, Bespoke Investment notes the S&P 500 recently hit six new records over a 12-day period. But while stocks have been on a nice run recently, the number of new highs this year (19) is the same as last and hardly indicative of unsustainable momentum. Indeed, Bespoke notes new highs tend to be clustered over multiyear periods; that was the case between 1954 and 1968 and again between 1980 and 2000, with long droughts tending to follow such periods. The latest period began seven years ago in 2013, when stocks finally began hitting new highs. “It may seem like the current 10-year market run has become long in the tooth”, says Bespoke. But if it’s anything like prior periods, “it could be another few years at least before occurrences of record new highs start to dry up”.
Investors are getting excited
Fund managers are not the only ones feeling bullish right now. Ned Davis Research’s crowd sentiment poll, a composite indicator designed to track changes in investor psychology, has hit optimistic extremes. American Association of Individual Investors (AAII) polls show in each of the last two weeks more than 40 per cent of investors have described themselves as bullish – the first time that has happened in 2019.
The percentage of bears has collapsed; the jump in the AAII’s bull-bear spread over the last month has been one of the biggest on record. The average newsletter writer, notes SunTrust Private Wealth, is now recommending more than 70 per cent equity exposure, compared to just 8 per cent in early October. In other words, retail investors and newsletter writers were running for the exits after stocks tumbled in early October. Now, following a furious 8 per cent rally, they’re bullish. Everyone has heard Warren Buffett’s line about being greedy when others are fearful and fearful when others are greedy, but acting on it is another thing altogether.
More cliches mean poorer stock returns
Investors should be wary of corporate cliches. When More Or Less Is Less: Managers’ Clichés, a new study analysing more than 78,000 earnings calls, has found managers use more cliches when performance is bad. A portfolio consisting of long positions in companies that used no cliches and short positions in companies that used at least four cliches earned average returns of 2 per cent per month, the study found. Why? Managers don’t want to give negative news and they don’t want to lie, noted the researchers. Instead, they resort to cliches. Does it work? No – even after controlling for negative earnings news, the study noted, investors correctly react negatively to cliches and the share price falls.
