US Outlook – GS Inc With quarter (and half-year) end approaching, many are wondering whether market participants will use one of the summer's biggest liquidity events to add or reduce equity exposure. Clearly, simple asset allocation models will predict large equity notionals for sale (given 20% outperformance of equities over treasuries QTD), yet there are a number of other factors which could provide a worthy counterbalance to this potential selling -- and limit it's impact:
1. US Mutual Funds are beating the S&P 500 by the most in 26 years. According to Morningstar, Active U.S. Equity Funds were up 7% through the end of May (vs the S&P 500 +3%) - the biggest gap since 1983. A lower correlation and realized vol environment (more on this in point 3 below) has led to a far more attractive fundamental stock picking landscape. Anecdotal feedback from PM's is that they continue to see the environment as favorable, and will continue to deploy cash balances, even with a strong start to the year (and especially with the index in positive territory). TrimTabs also reports that hedge funds had record performance in May (+5.6% monthly return is the highest since the dataset began in 2000).
2. US Pensions are still broadly underweight equities. In a June 4 report, Michael Moran estimated that 80% of pensions were underweight equities as of the end of '08). In late May, TrimTabs estimated that if both Private and Public pension plans decided to fully rebalance, this would constitute approx US$450BN of equity buying. Even half this number would represent approx 2% of the mkt cap of all U.S. stocks. While it is clear to us through conversations, and our futures and PT flows, that pensions have done a lot of work correcting this underweight, there appears to be a lot more wood to chop. It is important to note that while asset allocation models may predict quarter end outflows - this assumes that pensions have been consistently rebalancing up until this point in time. Conversations with a broad array of pensions tell us that this has not been the case - hence our conviction that pensions are still underweight equities.
3. Equity markets are seeing a period of relative stability (a signpost institutions have looked for). In the last 3 weeks, the S&P 500 moved less than 1% on the day, 75% of the time (11 out of the last 15 days). This speaks to the magnitude of how much markets have calmed, and it is no surprise that realized volatility continues to bleed lower (Vix is now at pre-Lehman levels). While many people are talking about the pullback we have had - we have really been treading water for the last 2 months (on moderate volume) - holding an 880 - 950 range since the start of May. Remember that while we are -5% off the Jun 12 highs, we are still 36% off the March 9 lows!
4. Flow of funds continues to be very supportive for equities. AMG has reported 13 out of 15 weeks of net inflows (totaling approx US$11billion note: this week saw a small outflow) and Money Market Funds continue to see record outflows. Our flows clearly support this theme of money going into equities - since April 1st we have been net-to-buy through our program trading franchise approx 75% of the time (43 out of 58 days) - alongside a +15% rally in the S&P 500. The important thing to remember is that the amount of inflows still pales in comparison to the $100billion to US$180 billion of outflows in 2008. Key takeaway: while the trend is constructive, and there is money being put to work, there is clearly a lot more dry powder on the sidelines.
5. The trend is your friend. The mkt has moved in the same direction the day following quarter-end, 5 out of the last 6 times. The mkt has moved in the same direction the day following half-year end, 4 out of the last 5 times. The mkt has moved in the same direction the day following month end, 5 out of the last 6 times. One other trend worth noting - the market has traded higher on 5 of the last 6 quarter ends.
This is the most popular chart of Q2, money market assets/US equity market cap. having hit a 30 year high of 60%, it has come back to 42%, but still well above the long term average of 20%
