Manager Survey Flashes Warning Sign

There’s one piece of market-related data that I check faithfully – and I believe all serious investors should do the same.

It’s the monthly survey of fund managers from around the world, conducted by Bank of America Merrill Lynch.

The latest survey includes 201 fund managers with a total of $576 billion worth of assets under management, and it tracks where these big money managers are investing their money.

Rather than following the fund managers into crowded investments, though, I use the survey as a contrarian indicator.

Think about it: If all of these managers are piling into certain trades and out of others, I want to position myself the opposite way. In fact, Bank of America itself uses the survey as a contrarian indicator, which I’ll explain later.

Latest Survey Shows Very Crowded Trades

My years in the investment industry taught me that job preservation is one of the strongest instincts on Wall Street – and it leads to herd behavior.

You see, fund managers who are positioned similarly to their peers have relative job security, even if the market tanks, and even if people who owned their fund lost a bundle.

Thus, my radar went off after I read the latest Bank of America survey. Fund managers all seem to be piling into the same trades once again. Think of a small canoe in which everyone has piled into one end of the boat.

Here’s the breakdown of their consensus trades, as revealed by the survey:

• Long U.S. dollar and U.S. stocks – particularly tech and financial stocks.
• Long other overowned sectors, such as consumer discretionary and real estate.
• Short emerging market stocks and currencies.
• Short commodities and related stocks.
• Short other underowned sectors, including industrials and consumer staples.

Bank of America said the most vulnerable tactical trade heading into the expected December Fed rate hike is long dollar and the associated trades (short commodities, emerging markets, etc.).

In other words, if Janet Yellen doesn’t pull the trigger (again), these managers may be talking about “black swans” on CNBC. I call this the “Three Stooges defense,” because Curley was always claiming to be a “victim of circumstance.”

Even if the Fed does raise rates a tick, I wonder whether there’s anyone left to pile into these already overcrowded trades.

Bank of America specifically pointed out the discrepancy in sentiment toward U.S. stocks and other equity markets. It said we now have the “largest ever U.S. equity overvaluation versus the rest of the world.”

Keep in mind that this is not a call on U.S. stock valuations, but a call on fund manager sentiment.

Michael Hartnett, Chief Investment Officer for Bank of America, said, “We are sellers of risk SPX 2050-2100.” Basically, they don’t think the S&P 500 is going past the 2050-2100 range, at least for now. Or, in other words, they’re using their own survey as a contrarian indicator.

Seeing the overcrowded trade reinforces my call to start looking at the much-hated emerging markets – especially since fund manager selling has pushed emerging market valuations to all-time lows.

The MSCI Emerging Markets Index is trading at just 12.8 times 10-year average earnings. That’s below the previous low of 13.5 times, which occurred during the 1997-98 Asian Financial Crisis. And the cyclically adjusted price-to-earnings multiple is now barely half of its long-term average of 25 times.

Bottom line: I know which end of the boat I want to be in. How about you?

Good investing,

Tim Maverick