There are many great quotes out there about the dangers of groupthink and herd mentality as they relate to trading the financial markets. One appropriate right now: “It’s better to be a lion for a day than a sheep all your life.”
In late January, Bank of America-Merrill Lynch did a survey of asset managers, the sheep in our story, and asked them 2 questions: What are your biggest concerns? And which fixed income market will provide the best risk adjusted return over the next 12 months?
You won’t believe their responses.
Far and away the biggest concerns of the asset managers surveyed were China and oil prices.
85% responded that China was their biggest concern and 75% said oil prices were at the top of their list. Both of these are legitimate concerns.
Being a good contrarian, whenever I see a survey like this, I immediately look at the items that are at the bottom of the 'concern' list. I want to know which concerns are on the fewest people’s radar screens.
To that end, there was one concern that didn’t receive many votes - slower US growth. It's no secret that the US data so far this year has been lackluster and the latest manufacturing and non-manufacturing reports show that the US continues to lose momentum.
Manufacturing is being killed by the trifecta of weak global demand, a strong US Dollar and rising uncertainty. Couple this with a service sector that is growing at its weakest pace since October 2013 and you get a composite reading of both sectors together that is the worst in over 2 years.
Growth Slowing Anyone?
On top of that the Fed released its latest quarterly loan officers survey. Yes, another survey. And one that few people are discussing. The survey showed that lending standards tightened for the second straight quarter. Well this has never happened before without the US eventually ending up in a recession.
Now I’m not calling for a recession, I’m merely pointing out that the 90% of asset managers surveyed who aren’t concerned about US growth slowing ought to take notice. We don’t need a recession for things to get far uglier than they are now. It should also be pointed out that a recession doesn’t happen against the backdrop of employment growth that the US has been reporting.
I track two different proprietary indices that help me track what markets think about future US growth, but in real-time.
One of the indices is a basket of assets that perform well on a relative basis when US growth is accelerating (High Growth Index) and the other tracks assets that outperform on a relative basis when US growth is slowing (Slow Growth Index).
My High Growth Index has fallen 12% this year and 2% over just the last 2 weeks. On the other hand, my Slow Growth Index has returned 6% year to date and 3.5% in the last 2 weeks.
US fundamentals are slowing and the markets are corroborating that story, yet 90% of asset managers surveyed by one of the largest banks on Wall Street don’t think it’s a concern. I love the smell of opportunity in the morning.
Based on the fact that the survey respondents weren’t concerned about slow US growth, it should come as no surprise that leveraged loans and high yield bonds topped the list of the best areas of the fixed income market for risk-adjusted return over the next year.
Are you serious?!
While it's true that both of these markets have been absolutely dismantled over the last 6 months, I refuse to be Captain Bottom Caller or catch a falling knife.
We analyze markets using a framework that evaluates the interplay between the fundamentals, quantitative and behavioral aspects of the market in question. Our framework is telling us that the downside move in both of those markets is just getting started.
Coming in No. 6 on the list with a tepid 10% of the respondents’ votes was US Treasuries. Out of all the areas in the fixed income market I could put money for the next 12 months, USTs are 6th on the list?
This is completely nuts to me but at the same time it's music to my ears. It tells me that the upside move in long-dated Treasuries, specifically TLT, is just getting started. Remember, this survey was done in late January, so the carnage of the first month of the year was well known to these asset managers. And they still put Treasuries 6th on the list! Despite the fact that TLT is already up 7% for the year, our framework is telling us that all systems are a go for the TLT bull.
The entire US yield complex continues to fall, largely because the notion that the Fed will continue to raise interest rates this year is fading away. Everything could change, of course, if the incoming economic data turns out to be stronger than expected. Until then, yields are saying that there are very real concerns about US growth, despite the perspective of asset managers partaking in surveys.
The 2-year yield, which is the most sensitive to rate expectations, has fallen sharply this year, decreasing to a 3-month low. The 5-year Treasury yield is back below 1.3%. Yields rose in November when the market realized that the Fed is about to hike rates. That increase has now been fully reversed, and then some.
And finally, the benchmark 10-year yield’s tumble is even more dramatic, sliding to 1.87%–the lowest level since last April.
Fun fact of the day: Keep an eye on the 1.5% and 1.0% levels; if the 10-year slides that low, it means the odds of a US recession have risen to 60% and 70% respectively.
So the fundamentals are behind TLT and so are the quantitative and behavioral aspects of the long-dated US Treasury market. Quantitatively, TLT is clearly bullish and yet not overextended. It's had a very strong 2 weeks and so a time of consolidation is to be expected before its next push higher.
From a behavioral perspective, the historically SHORT speculative positioning in the Treasury futures markets has been slowly reversing itself but remains extremely tilted to the SHORT side. There is plenty more short-covering fuel to add to the fire and once the 86% of asset managers survey realize that Treasuries should be No. 1 on their list and not No. 6, the initiation of LONG trades will help keep the rally going, long after the shorts have been burned.
90% don’t think US growth slowing is a concern and 86% don’t think US Treasuries are a good risk adjusted investment for the next 12 months.
Don’t be a sheep.
Don’t try to call bottoms in markets that are plummeting, or catch falling knives. Don’t chase performance and allocate money to investments that have already made their move. Don’t chase markets that have already run really high or really low because you’re scared of missing out on the next move.
Trade like a lion. Opportunistically look for non-consensus ideas and wait for them to become mainstream. Be the lion who is selling to, or buying from, the sheep, well after the truly smart money has been made and the move is almost over. If you’re long TLT, stay with the trade. If you haven’t initiated a TLT trade proactively look for an opportunity to do so.