For much of the first quarter, it seemed as if many investors lacked confidence in the stock market’s rally, judging from where they put their money.
Investors pulled $46 billion out of equity funds this year through March 14, according to data compiled by Bank of America Merrill Lynch. The outflows stood in such stark contrast to the market’s continued ascent that various strategists described it as a “flowless rally.”
Flows have finally turned bullish, says Michael Hartnett, Bank of America’s chief investment strategist. Equity funds poured $14.2 billion into the stock market last week, dominated by purchases of exchange-traded funds, according to BAML data. It was the biggest weekly inflow since March 2018.
And so, it’s clear that investors have not yet given up all hope on stocks. For Hartnett, the burst of inflows showed the resilience of risk assets in a lengthy bull market that provides reasons to take profits ever so often. One such excuse was the extension of the US-China trade negotiations in February — an event that Hartnett said was met with minimal profit taking.
But don’t count on investors to keep piling up their gains indefinitely. In fact, emerging-market debt and equities have become the most crowded places for investors to put their cash to work, according to Hartnett. Developing markets outside the US have become a popular destination of choice for investors looking for stocks with cheaper relative valuations, in countries that have lagged the US and could be poised for their own breakouts.
When investors pile in to a single trade with such intensity — as they did with tech stocks before last year’s correction or with bitcoin in late 2017 — the subsequent results have historically been poor, Hartnett said.
His counsel on which land mines investors should watch out for did not stop there: He further laid out the specific events that would serve as signals to sell stocks.
They’re anchored on BAML’s Bull & Bear Indicator, which gauges where investor sentiment lies on a scale of zero to 10. It’s a contrarian indicator, meaning it sends a sell signal when investors are extremely bullish, or when it crosses 8 on the scale.
With that established, here’s what would indicate to Hartnett that “extreme bullishness” has taken over Wall Street’s psyche — meaning it would be an opportune time to throw in the towel on stocks:
- If there are equity inflows of more than $50 billion over the following four weeks, implying that the extreme bullishness is amplifying itself.
- If BAML’s fund-manager survey shows cash levels of less than 4.5% and equity allocation up from 6% to more than 30%.
- If data from the Commodity Futures Trading Commission shows that hedge funds are long risky assets by more than 0.5 standard deviation versus neutral today.
Hartnett is also keeping an eye on macroeconomic trends separate what investors are doing with their money. Specifically, he’ll know the next economic recession is at hand when there’s a combination of higher claims for unemployment insurance and higher credit spreads.
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