Asset managers have turned decidedly bullish on the stock market year-over-year, a Bank of America Merrill Lynch report notes. The long-only investors in the survey are questioning the long dollar trade as well as shorting government bonds and they think tax reform will happen, it is just a matter of when.

2016 Hedge Fund Letters

Asset managers

Major asset managers turn bullish

Major asset managers have been deploying cash. The BAML Fund Manager Survey (FMS), released February 14, is a monthly survey of 200-250 primarily long-only investors.  The report showed that major asset managers have been deploying their dry powder, as cash holdings dipped to 4.9% from 5.1%.

The stock market is a buy, the BAML report noted, as cutting in cash holdings is supported by strong investor sentiment.

Nearly ¼, or 23%, say “boom” best describes the current economic environment. Compare this to 1% who responded similarly one year ago.  The second highest response, with 18%, describes a “goldilocks” not too hot, not too cold environment, while only 6% used such a descriptor one year ago.

Those lovely market sentiments contrast with 15% who say they see “stagflation” and another 43% who expect “secular stagnation.” While the numbers are high, the prediction for secular stagflation is down sharply from 88% one year ago.

Black swan catalysts

When considering potential black swan catalysts, survey respondents targeted the top two potential outcomes in 2017: trade protectionism and higher interest rates. Protectionism was on the minds of 34% of respondents when asked what will cause the next bear market.

The tax overhaul, if implemented with a border adjustment tax, is one such protectionist impulse. The best hedge against protectionism is gold, the survey respondents said.

Higher interest rates was a concern of 28% of respondents as US Federal Reserve Chair Janet Yellen indicated a wait and see approach to the Trump administration. The more ubiquitous “financial event” rated at 18% risk, while weaker earnings per share growth, an old fundamental indicator, was a concern of 15% of respondents.

When looking at the expected economic outcome of “populist policies,” the often negatively correlated inflation and stagflation responses were the most popular among 37% and 36% respectively. Recession and stagnation were the third and forth negative outcome, while a “goldilocks” response was only the likely outcome 7% of respondents chose.

Asset managers point to long USD as crowded trade with long banks

The long US dollar trade, at one point a big winner, has begun to pan out. The BAML fund manager survey may know why.

Long US dollar is the most crowded trade, the survey participants said, attributing the over popularity to the reason the dollar is down year to date. After touching bottom in April near $91, the US Dollar Index started the year near $103 and is trading Tuesday at $101.20.

In a distant second for crowded trade was the short government bonds and then Long US/EU corporate bonds. Crowded trades since December include long bank stocks, long US small cap stocks and short the Chinese renminbi currency.

The survey says a contrarian macro bear who is anticipating weaker growth would sell banks, US dollar, Japan, and buy bonds, utilities, staples. The strategy for the contrarian macro bull who anticipates expecting higher inflation would be to reduce cash, sell REITs, tech, and buy sterling, emerging markets and industrials.

Markets saw major fund managers move money out of Industrials, Utilities and Discretionary stocks and into Emerging Markets, Materials, the Eurozone and Commodities. Fund managers have short British pound and Eurodollar exposure.

When considering the much-discussed tax reform, 39% of respondents expected it would pass before the end of the year, the top response, while 23% said it would pass before August of 2017. No respondents said the plan wouldn’t pass while 30% predicted it wouldn’t pass before 2018.