Further strength in equities?
Abraham George Market Musings
For the last many months, I have been bullish on bonds, gold, oil, and equities; and bearish on the dollar. The bonds, gold, and dollar have played out well while the oil has not done that much. My recommendation was to buy oil in the lower 70s. So it is still a good play. Equities have not given a trending move as yet but I have argued all along that the October lows should hold.
Many things point to further strength in equities and I would like to put forward some observations that I did not cite in the previous two reports.
Sentiment indicators are good to consider but they should be looked at their extremes in terms of their history. The longer the history the better confidence that you can derive. One of the least talked about sentiment measures is compiled by TD Ameritrade one of the largest brokerage houses in the US. The company has more than 11 million individual accounts totaling over $ 1 trillion in assets. So it is not a small data set that we are analyzing. The brokerage calls it the Investor Movement Index (IMX). It includes data like account holdings, position changes, and trading activity. Every month's observations on this data can give you a good idea if their regular clients are bullish or bearish. Like all sentiment indicators, this is a contrarian tool. When the IMX reading is low and investors are scared one should consider buying and that’s exactly what the chart is telling us now. In 2022 it crashed through the low levels and hit its lowest levels in November and December. Since the index was created in 2010 this is one of the lowest readings.
When the majority of investors are positioned the same way, the stock market tends to have the opposite reaction. It is just the opposite of the “greater fool theory”. When everyone has bought into the same asset, there is no one left to buy. Then the path of least resistance becomes the downside. This we always see at market peaks.
Now let’s look at the most widely used sentiment indicator from the futures markets. Every Friday, the Commodity and Futures Trading Commission (CFTC ) releases its Commitment of Traders (COT) report. It is based on all the open interest of all options and/or futures contracts through the Tuesday prior. There are many ways to interpret this report but we want to look at the non-commercial positioning in particular. A commercial trader is a real money guy who uses the futures or options to offset a specific commodity or hedge an instrument to avoid any price surprises from his cost and scale of production. That happens all the time. But non-commercial traders are speculators who make a one-sided bet without an offsetting position. In most cases, they are hedge fund managers.
The best way to understand the current sentiment of the markets is to look at the open interest in the S&P 500. Based on the latest reports fund managers are almost as short on stocks as they were at the COVID-19 lows. In fact, these shorts have gone up since the start of the year. In my last report, I already pointed out the Put/call ratio holdings.
The current positioning is short close to 227,000 contracts which mean participants are anticipating the S&P 500 to head lower. The last two times the market was this pessimistic were during the April 2020 lows and the recent trough in October of last year. We all know what happened after that. The five-year average on this number is about long 16,500 contracts. So if the participants are wrong on their shorts now there is a lot of short covering to be done.
Why do you think the market is positioned like this? Firstly real money managers are very cautious and most have been anticipating disappointing results. So if numbers come in line with expectations or better than expectations it will hurt the short positions.
Then we have the cash position in the market. The cash position is at an extreme compared to its recent past. Investors have got about $ 4.8 trillion in money market funds. The figure was the same during the height of the COVID pandemic. It is also well above the five-year average of $ 3.9 trillion and marginally above the one-year number of $ 4.6 trillion.
Finally, the investor positioning on the markets based on the BOA global fund manager survey is at one of its 5 lowest levels in the last 25 years.
What about the recent price action?. Price is always an advertising agent but recent price actions should have many participants concerned. In the last many sessions, markets have been down in the Globex markets but markets are up during the cash market sessions in the US. The liquidity is all in the cash market. So we can fairly assume that real money and institutional managers are starting to buy.
This is all happening in the wake of a break out in the S&P 500 and a Fed meeting next week that could surprise many for further upside in the markets.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office, and a hedge fund.