Good news for markets – fund managers are feeling jittery

At the end of the day, in the words of the old City joke, markets go up because there are more buyers than sellers.

Your story can be as sexy as you like. Your fundamentals can be as solid as a rock. But, ultimately, what matters for share prices is the amount of money flowing your way. (Or not, as the case may be.)

In turn, that money flow is based on expectations. People put their money where they expect it to be treated well.

So what expectations do the world’s biggest investors have today?

Global fund managers don’t feel too upbeat

The Bank of America Merrill Lynch global fund manager survey comes out every month. The reason I pay attention to it is because it gives me at least some idea of how the people who direct the flow of a fair chunk of that money – global fund managers – are feeling about the state of the world.

Being instinctively contrarian, I look out for what the majority views are, and whether the overall “feel” is overheated or not.

From that point of view, July’s survey is pretty good news. It’s hard to argue that investors are feeling overly bullish.

For a start, fund managers are holding an average 4.7% of their portfolios in cash. That’s not the highest on record by any means (it got to over 6% in the wake of the tech bubble bursting) but it’s still higher than the ten-year average of 4.5%.

In other words, fund managers aren’t “all in”. They see a lot of things to worry about, and a lot of reasons to hold onto some cash. And they’re quite right too.

For example, if I was a global fund manager, then yes, I’d probably be worried about a trade war (as 60% of them are). In fact, you have to go back to the eurozone crisis to find this many fund managers specifically worried about one big issue.

This probably explains the asset that they are most bullish about too (the “most crowded trade”, as the survey puts it) – that is, long FAANG & BAT. This acronym includes all the big US and Chinese tech stocks (Facebook, Amazon, Apple, Netflix, Google/Alphabet plus Baidu, Alibaba and Tencent).

The giant tech stocks are almost a safe haven trade right now. They’re not “safe” like a US Treasury bond is “safe” – they’re still volatile and vulnerable to disappointment (as happened the other day with Netflix’s slightly under-par results).

However, they are safe in terms of “career risk”. If you are a professional equity investor, then you have to have most of your money in equities whether you like it or not. If you also feel nervous about a crash, what can you do?

Simple. You make sure you own the stocks that everyone else owns and that everyone else agrees are great stocks. That way, if you take a hit, so does everyone else, and you don’t stand out. The tech giants have become akin to the “nifty 50” stocks of the 1960s and early 1970s.

Investors are also turning sceptical about inflation, economic growth and rising interest rates. In fact, they’re at their most gloomy on this front since March 2011. Add it all up, and it’s hard to argue that global investors are feeling overconfident.

Markets can be overvalued for a very long time

That’s a good sign. There’s no doubt that the market is overvalued right now on any number of fundamental measures. But a market can remain overvalued for quite some time before gravity catches up.

Markets are all about expectations – which is why it matters that fund managers are feeling cautious. As long as the hopes and dreams embedded in the market aren’t too far out of whack with what actually gets delivered on a day to day basis, then markets can keep going for a long way, based on faith and fear of missing out.

I read a very good blog from Josh Brown (of The Reformed Broker blog) the other day. He was highlighting an article he’d read in American financial newspaper Barron’s.

Here’s a quote: “Given a continuation of the ‘Goldilocks’ economy — not too hot, not too cold, with inflation safely closeted — stocks, and multiples, could go higher still. In fact, bulls, bears and agnostics alike have begun to speak of a ‘classic blowoff’, or buying panic, that could engulf the market by year-end.”

Big deal. You read the same thing every day in every other financial newspaper at the moment.

Thing is though, this was an article from 1997.

At that point, the bull market still had another couple of years to run. By the time it was over, markets had gone from being simply overvalued to being more overvalued than they ever have been in the history of markets (and, notably, even more overvalued than they are right now).

It’s a salutary lesson. If you have a tendency towards bearishness (and I’ll put my hand up right away), it’s particularly worth learning.

It’s fine to be aware of overvaluation and to adjust your asset allocation accordingly. But don’t try to time the market. If you think “this looks expensive” and go to 100% cash, planning to sit out the crash and look like a genius – well, you’ll end up being very frustrated, at the very least.

Here’s another interesting line from that 1997 article, attributed to one Jeffrey Applegate, then a strategist at Lehman Brothers. “Bull markets end when valuations get wildly extreme, or earnings fall apart, or inflation rears its head.”

Back then, in the tech bubble, it was the first of these three that did for the market. Valuations simply became unsustainable for even the biggest bulls to suspend their disbelief.

This time around? I’m still betting on inflation.