Earnings season off to a good start, Institutional investors wait and see, Where do institutional investors see the highest risks?
Chart of the week
Source: YouTube Markus Koch Wall Street from 19.07.2022, Timestamp: 5.16
Bank of America surveys the largest institutional investors, such as pension funds, banks and insurance companies, every month. One question it has asked since the survey began in 2001 is how risky investors are currently invested. The current reading is the lowest since the survey has been conducted, and lower than during the financial crisis.
Why that is important
The indicator is considered a contra indicator. If the largest investors are on the move with a small risk, they have already sold everything they wanted to sell or have hedged with forward transactions. So there is no big selling pressure to be expected anymore. Even small purchases can drive the stock market up.
When investors change their minds, a lot of money flows into the markets and drives prices up. So currently is a good time to get back into the markets.
Earnings season off to a good start
Traditionally, banks are the first companies to report Q2 2022 financials. However, Tesla also announced its results this week. The picture of the first earnings reports was mixed, but on average slightly positive.
In the next week, many other companies will follow, as well as Apple or Amazon. In addition, the publication of GDP growth (gross domestic product) for the US is due on July 28. After the decline in the last quarter of 1.5%, an increase of 0.9% is now expected. If the value is negative against expectations, this would mean that we are officially in a recession.
According to the definition of a recession, this requires two quarters of negative growth. So if the value were to be positive now, a recession in the US would not be possible until 2023. This would be good news for the stock market and for many politicians in the USA, and would have a major impact on the upcoming general elections in the USA.
Record high negative futures positions
Source: YouTube Markus Koch Wall Street from 20.07.2022, Timestamp: 12.13
The chart shows how many investors bet on rising stock markets with futures (futures long, positive value on the chart) or bet on falling prices (futures short, negative value in the chart above).
In recent weeks, massively more investors have built up short positions in futures. This can have two reasons:
- Hedge funds were betting on a stock market collapse. With high short sales in futures, which are also highly leveraged, they would make a lot of money if the stock market collapsed now.
- Large institutional investors hedge their equity holdings with futures. Selling futures is like taking out insurance. If the stock market falls, the value of the futures rises to the same extent.
To achieve the high negative values in the chart above, both cases are needed. Therefore, many hedge funds are currently betting on sharply falling prices.
Digression: Hedgefunds, Leverage and Margin-Calls.
Hedge funds are often highly leveraged. What does that mean? Let's assume a hedge fund has 1 million of its own funds. It now borrows 50 million from a bank, which it invests in the market. So currently it is short the S&P 500 for 50 million in futures, speculating on falling prices. So the hedge fund invests with a leverage of 50, which is quite common and can even go up to a leverage of 100.
However, if the index rises by 2%, the loss on the position adds up to 1 million, exactly the hedge fund's equity. The bank now sends the hedge fund a request to either add more equity or close the position immediately. This is called a margin call. Since the hedge fund has no more equity, its position is forcibly liquidated by the bank. To do this, the bank buys back futures on the market for 49 million that the hedge fund had previously sold short. This causes the stock market to rise further.
If very high short positions are in the market, as is currently the case, this can lead to a domino effect. More and more hedge funds are thwarted, and their positions are forcibly liquidated by the banks. In such cases, the broad index can rise 3-5% per day.
In the current situation, such price jumps are very likely for the next few weeks. A GDP growth on July 28 that surprises positively could trigger a chain reaction as described above.
Institutional investors wait and see
Source: Isabelnet, 19.07.2022
The chart shows in blue the same as the previous chart, i.e. the net futures positions on the market, but this time together with the US ISM index. The purchasing managers index in the U.S. is considered one of the most important leading indicators, for economic growth. As you can see in the chart, the correlation between the two indicators is very high and the current high divergence is exceptional. For us, it is an indication that the markets are currently too negative or that a slump in the ISM index is already priced into the prices.
Source: Isabelnet, 20.07.2022
The Bank of America survey of all large institutional asset managers cited at the beginning also asks how high their cash reserves currently are. As can be seen in the chart, they are at their highest level in 20 years. Higher than after the Covid crisis or the financial crisis. The crucial question now is when this money will flow back into the market and drive prices up.
Source: YouTube Markus Koch Wall Street from 20.07.2022, Timestamp: 12.39
The chart does not show the net positions in open futures as in the previous charts, but only the short sales (red line). It therefore only covers those investors who are leveraged.
In all cases where short selling was negative to the same extent, there was an upward counter-reaction in the S&P 500.
Where do institutional investors see the highest risks?
Source: YouTube Markus Koch Wall Street from 20.07.2022, Timestamp: 15.10
In a monthly survey by Bank of America, all large institutional investors are asked where they see the highest risks, or where a price bubble has formed that could burst.
Most investors see the highest risk to portfolio returns from betting on a further strengthening USD right now. Commodities are also still seen as too high, even after last week's correction.
Very surprising and from our point of view not justified is the mention of "Long ESG Assets", i.e. all stocks of companies that have included an implementation of sustainable policies in their corporate philosophy and are committed to ecological and ethical behavior. We think this is a long-lasting trend and not a short term bubble.
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