Expected consolidation has begun, time of extreme positions, positioning of the world's largest investors

Chart of the week

Since 1789, the chart shows the interest investors have received for a 10-year government bond, minus inflation. This is called the real yield.
Why this is important‍

Everyone is talking about the fact that interest rates are now rising again. So these are good times for bond investors, because they are now getting more interest again. The decisive factor is not nominal interest rates, but interest rates after inflation, i.e. real interest rates. Currently, bond investors are getting more interest, but inflation is at an all-time high and is eating away at the yield. The best investment in times of high inflation is stocks. With inflation rising steadily, stocks are considered the best investment with inflation protection. Companies own many real assets that rise with inflation and can also raise prices to maintain their margins.

Expected consolidation has begun

90% of companies have now published earnings for the second quarter of 2022. Until last week, 75% of the companies beat expectations. That is a very good value. This week, however, only 50% of the companies beat expectations. This was enough to break the steep upward trend of recent weeks.The economy in China is not doing well. The constant closures of entire regions because of the Covid-Zero policy and the still smoldering real estate crisis hurt the country more than expected. This week, energy rationing due to drought was added to the mix. The weak economy may be one reason for China's harsh reaction against Taiwan, but at the same time, in our view, it is also the reason why the situation should not escalate further. Xi Jinping is seeking a third presidential nomination from the People's Congress in the fall. He is under internal pressure because of his economic policy. A conflict with the United States and Taiwan is uniting the ranks. At the same time, however, he cannot risk a war with Taiwan and the U.S., because the same sanctions would then be levied against China as against Russia. The economy in China is currently too weak to cope with this, or the danger that before the re-election of the economic situation completely out of control.shocked the stock market has also the very high inflation figures in England of over 10%. All these developments have led to the fact that the stock market has now entered a consolidation phase.

The chart shows how many stocks are currently trading above the 50-day average. It is worth looking at such "technical indicators" to better assess the market. June was still an excellent time to enter, since then the market has risen more strongly and quickly than it has in a long time. So a consolidation seemed inevitable. However, such aspects are more interesting for short-term investors.  Medium and long-term investors, among whom we count ourselves, remain invested even in such phases. The stock market always fluctuates back and forth; it is important to recognize the general trends. And this includes the correlations that we have listed above under the chart of the week.

The chart shows the US Purchasing Managers' Index (red, ISM PMI) and new orders minus inventories. Currently, inventories are increasing strongly. After the COVID period with many supply bottlenecks, it is understandable that many companies are now increasingly replenishing their inventories. Usually, however, this is a signal that production figures will soon be decreasing. A little caution is therefore definitely in order when investing.

The chart shows the development of short-term interest rates of 2 years compared to the S&P 500. As explained in many of the previous blogs, the development of interest rates is crucial for the further development of the stock markets. In recent weeks, stock market prices have been able to decouple from bond interest rates. However, this was also the case in March and April of the year. We believe that these two lines will align again. This can happen either through falling interest rates or falling stock prices.

Time of extreme positions

Every three months, major investors in the U.S. must disclose to the SEC what positions they have. This allows us to monitor the activities of some of the largest and most successful investors in the past. Currently, the figures could not be more different, which also reflects well how difficult it is currently to develop a good investment policy. Michael Burry, who is surely known to many from the movie "The Big Short" has sold all his positions that he has. For example, Amazon and Apple. At the beginning of the year he bought for 55 million. Michael Burry foresaw the real estate crash of 2007 and earned hundreds of millions with it. He currently believes that the reduction of the Federal Reserve's balance sheet plus the interest rate hikes will lead to a total collapse of the economy and the stock markets. He compares the stock market to a drug junkie who is deprived of drugs (cheap money).On the other hand, we have Warren Buffett. One of the world's most famous investors. In 1954 he started his investment career with USD 105'100. Now his assets amount to over USD 110 billion. Warren Buffett is a long-term investor who specializes in substance stocks. He embodies the investment philosophy of Benjamin Graham, the founder of (deep) value analysis, like no other investor. Stocks are bought at a discount of over 30% to their intrinsic value and held for the long term. Warren Buffett has added heavily to most of his positions in recent weeks. For example, Amazon.

Positioning of the world's largest investors

‍Every month, Bank of America's survey of large institutional investors on how they view markets and how they are currently positioned is interesting. Institutional investors are responsible for about 85% of the total trading volume. Their decisions move the markets.

Here, institutional investors were asked how heavily they are currently invested in equities. The equity weighting is below average for most investors. They are either in cash or have hedged their positions with futures. Institutional investors have to be invested at 100% for the most part and can only park their money in cash for the short term. This is positive, as a lot of money can still flow into the market and drive it up.

Here, investors were asked where they currently see the highest risks. Fears of a global recession have remained as high as last month, but more and more investors fear that inflation will remain high for longer. As explained above in the Chart of the Week, equity investments are just the thing to protect against inflation here.

Here, investors were asked what would happen if the U.S. Federal Reserve did not raise interest rates further. Most assume that this will only be the case when inflation falls below 4%. Even in the most optimistic forecasts, this is not the case until next year.Also mentioned is a level of the S&P 500 of 3500. That would be a further loss of 20%. Currently, therefore, it cannot be assumed that the central bank is fixed on stock prices. There is currently no FED put as we have often had in recent years.

Here, investors were asked whether they thought growth stocks or value stocks would perform better in the coming months. A value above the zero line means that value is expected to outperform. The camps are almost the same size, but for the first time since May 2020, slightly more investors expect growth stocks to outperform in the coming months.

Here, investors were asked in which asset class they currently see the greatest dangers, or where everyone is already invested and the trend is unlikely to continue. The strong USD is clearly in first place. The large institutional investors will therefore hardly expand their USD positions any further and will rather reduce them. Here, however, much depends on the course of the war in Ukraine. In the event of global uncertainties, investors "flee" into the USD.

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