Today I have just two very straight forward charts to share, one the subject of bond valuations, the other on the flow of money into equities – which shows no sign of tamping down!
The first chart comes via a LinkedIn post by a fixed income portfolio manager at Asian manager GaoTeng Global Asset Management. In very simple terms, it restates what is I think still a rational, bullish view for bond valuations. It argues that “even with yields close to zero. Counting for inflation and taxes, interest rates aren’t particularly low. Interest rates have just as much a chance of declining as rising. Many of you will have difficulty accepting this. The almost-universal narrative these days is that, because U.S. rates are at record lows — close to zero, in fact — their path is undoubtedly up. Bonds in turn will suffer. But this widely-held narrative fails to take into account both inflation and taxes. Once you do, it becomes clear that interest rates now are not even close to being at all-time lows…”
As for equities, everyone and their aunt thinks that US shares are over bought, and arguably overvalued. But in truth much of this momentum is illusory as investors have actually been running relatively low levels of equities within portfolios, relative to cash, other asset classes and the historic record.
Analysts at Deutsche Bank have been tracking these numbers and found that since bottoming at record lows in March (-2sd), their consolidated indicator of equity positioning – see chart below – has moved steadily higher and “is now back within its historical range, albeit still on the lower side (-0.4sd, 20th percentile). It is at levels seen a year ago in August amidst a flare up in trade war fears”.
The Deutsche analysts reckon that forward returns (over 1m horizons) tend to be inversely tied to the level of positioning (Positioning And Forward Returns, Jun 19 2020). “At the extremely low levels of positioning prevailing over the last 4 months, associated forward returns were strongly positive on average (+3%) and consistently so (80% to 100% of the time). At current levels, associated forward returns are still positive but more modest on average (+1%), and with a somewhat higher risk of turning negative (one-third of the time).”
One crucial underpinning for Q4 equity demand could be the resumption of share buybacks.
“Buybacks fell to just $30bn on net in Q2, down from $175bn in Q1, as an overwhelming majority of companies suspended them. However, buybacks tend to be extremely cyclical and as we noted yesterday, many companies have already resumed buybacks or have at least indicated that they may do so opportunistically. As earnings pick up in Q3, buybacks should also bounce back, although the extent is likely to be tempered in an election year to the benefit of M&A.”