My guess is that the nasty bout of market volatility over the last few weeks was a small tremor and not the start of a big sell-off. To repeat – despite this short-term positivity, I am much more cautious over the medium term and think that a really big market crash is on its way at some stage in 2019. Paradoxically,  I also think the gloom and despair at the moment is overdone. My hunch is that we are now quickly moving to a new kind of uncertain market normal, where markets drift for a while, then surge – then sell off. Along the way market volatility starts to steadily creep up.

In the meantime, though we should expect intermittent bouts of half decent macro news, most of it coming out of the US, where the national economy is obviously firing on all cylinders. But at the global level, we should also expect support from other market factors, not least burgeoning corporate profits feeding through into higher dividends. According to Janus Henderson, Q3 dividend payouts rose 5.1% “to a comfortable third-quarter record of $354.2bn. The United States, Canada, Taiwan, and India all saw all-time record quarterly pay-outs, while Chinese dividends returned to growth, after three years of contraction.”

These kinds of numbers will, I think, sustain a continued rotation into equities. Given that all financial assets look overvalued (with the arguable exception of gold), equities globally look the least overvalued (outside of the US) of the bunch.

Given this analysis, I’m not surprised that investors are starting to buy back into risk assets. Or at least that’s the story this morning from Deutsche Bank’s latest investor positioning report, which suggests that equity inflows are actually holding up well. Highlights from the report include:

  • “Equity funds received inflows for the 3rd time in 4 weeks. Equities saw large outflows in the first week of the sell-off in October but flows have held up since then despite the market choppiness. In the last 4 weeks, equity funds have seen inflows of $15bn, offsetting the initial outflow. This week, US equity funds (+ $2.6bn) saw inflows return after 2 weeks of modest outflows. EM (+$1.1bn) inflows continued for the 5th week in a row, albeit at a slower pace. Flows into China funds (+$0.7bn) slowed after extremely strong inflows over the last four weeks. Japan did not see any flows this week after record inflows in the last four weeks. European funds (-$1.3bn) however continued to see outflows for the 10th week in a row, in line with weakening data surprises.
  • Defensive and bond like equities getting inflows again. After steady outflows for the last 2 years, defensive and bond like equity funds, such as those dedicated to Utilities, dividends, minimum volatility, etc. have started to see inflows again over the last 3 weeks ($2.2bn). Cyclical sectors, on the other hand, are seeing outflows, particularly from Financials, Industrials and Materials. Technology funds have also been seeing outflows over the last 2 months after enormous inflows in the first 9 months.
  • Has a rotation out of Growth and into Value funds begun? Value funds have seen inflows for the last 3 weeks ($2.9bn), a rare occurrence in the trend of relentless outflows for several years. Growth funds, on the other hand, have seen steady outflows since late September after strong inflows in the earlier part of the year. ETFs seem to have led this shift with inflows to Value (+$6bn) exceeding inflows to Growth products (+$1.7bn) in Q3.
  • Large cap inflows continue but small- and mid-caps seeing outflows. Large caps have seen inflows in each of the last 4 weeks ($12bn) after the large outflow during the initial sell-off in October. Small caps saw modest inflows (0.8bn) but this follows several weeks of outflows while mid-caps continued to see outflows.
  • Large outflows from credit funds. Bond funds (-$5.3bn) overall saw large outflows this week, but mostly from credit with HY (-$2.3bn), HG (-$0.6bn) and EM (-$0.6bn) all seeing outflows. HY funds are on track for their 13th straight month of outflows, totaling -$100bn. In fact, the steady outflows have meant that HY funds have now given back all of the inflows they saw from 2009 to 2014. HG funds have also been seeing outflows over the last one year but they have been modest by comparison (-$28bn) and follow a 9 year stretch of enormous inflows.
  • Investors added S&P 500 futures exposure after 5 weeks of outflows. Non-dealer net positioning in S&P 500 increased +$4.9bn wow after 5 consecutive weeks of declines totaling -$36bn. This week’s new allocations were driven by Asset Managers who added $4.4bn in long exposure and took off almost $6bn in shorts. Leveraged Managers continued to cut long exposure (-$3.2bn) and added shorts (-$1.8bn).”

Will oil prices rebound?

Short positions on oil have rocketed as the price of oil has dropped by $20, the biggest decline since 2015 – remember that oil positions have historically been correlated (inversely) to US dollar futures positions. Deutsche now reckons that “From being too high relative to dollar positions, oil positions are now too low. More CTAs likely flipped short oil this week, as WTI’s 50d MA crossed the 150d MA on November 13th. This is consistent with the futures data where we see a pick-up in WTI shorts likely driven by CTAs and cuts in longs likely driven by global macro funds. US Energy underperformed S&P 500 by -9% since October 11th, but long-short style factors within the sector almost all posted positive returns over the same period led by dividend yield, earnings yield, and low volatility.”

But the chart below from Darwei Kung, at DWS suggests a rather different (bearish) narrative about oil. He reminds that the OPEC quota regime – which has built some credibility – is scheduled to end this year. The DWS strategist argues that with ” factors such as the uncertainty in Iran sanction effectiveness, ramping up of production by Russia and Saudi Arabia, and the looming resolution of prior production disruptions in countries such as Libya and Nigeria, OPEC’s hard-won credibility has started to be doubted again. What’s more, a soft patch in several major economies continues to feed worries about a bigger slowdown, which obviously would have major ramifications for oil demand. All said the 6-month rolling total difference between demand and supply points to some further weakness down the road….”