Distribution Evidence and Sentiment Data

Zerohedge already remarked yesterday on the client order flow data published by BAC/ML, which show a lot of institutional selling in the US stock market, while concurrently retail clients have turned into large net buyers. This buttresses our recently voiced contention that one must be on the lookout for signs of distribution. This certainly qualifies as one such sign, even though it only shows what the firm's own clients are doing.

However, we wanted to briefly discuss another consensus that has emerged, one that is tied directly to the Fed 'taper' notion and what is really a very simplistic idea of what it will mean for the currency. Clearly, should money supply growth in the dollar area weaken relative to money supply growth elsewhere, this would be a long term positive for the dollar. However, one must not forget what has actually happened over the past five years, during which the supply of dollars has soared relative to the supply of euro, pound and yen. In spite of this, the US dollar has actually strengthened against all these currencies, for the simple reason that other factors can be far more important in the short to medium term (such as trader perceptions, market positioning by speculators engaged in carry trades, interest rate differentials, etc.).


Merrill also regularly surveys positioning and sentiment among a large group of fund managers globally (238 participants with total AUM of $643 bn.) and the most recent survey showed several interesting extremes of opinion. The most notable ones were on currencies, specifically the dollar and the yen. The percentage of fund managers bullish on the US dollar for the next year has soared to an all time high of 83% net. Concurrently, emerging market equity exposure has hit a 12 year low, even undercutting the 2008/9 crash lows. US equities are of course seen as the 'safest bet' – in spite of the fact that EM equities are finally actually cheap and US equities are well into bubble territory based on the Shiller p/e and Tobin's Q.

But that is how it goes – these fund managers tend to herd, until they are all in the same trades and are all shunning the same trades. Naturally, they also positively hate commodities and China right now. These may be fundamentally well-reasoned positions, but these people are certainly anything but contrarians. We would in fact say that as a group, they are playing whatever seem to be the most glaringly obvious trends at any given time. Keep in mind in this context how the commodities bull market began. It took about 5 years of rising prices before anyone on Wall Street even mentioned demand from China, and when they did, it was actually erroneous. The real and main driver of the bull market has always been monetary inflation.

These fund managers incidentally also often tend to be spectacularly wrong at junctures that see them all sitting on the same side of the boat. An example for this is e.g. provided by the yen (see below):



merrill survey-dollarThe bullish consensus on the dollar among fund managers is at the highest in the history of the survey – a big, fat 83%. The yen was only more hated than today in 2001, right at a major low that hasn't been seen since – click to enlarge.



Regarding the yen, see for yourself:



yen,LTHere is a long term chart of the yen – the bearish consensus was the biggest in the history of the survey right at a low that has so far held for 12 long years. At its peak, the yen had nearly doubled from there. The survey didn't yet exist at the 1998 low in the yen – click to enlarge.



A Closer Look at the Dollar

Given the well-known negative correlation between the US dollar and gold (as well as other commodities), this seems to be quite supportive of the idea that a major advance in gold could be in store. One thing is certain: an 83% consensus is very likely worth fading from a medium to long term perspective.

Let us look at the dollar more closely:



DXY-daily,one year

The US dollar index has been in a choppy uptrend since 2011. Recently, it has become a lot more choppy – click to enlarge.



The wild gyrations of recent weeks have booted some of the previously extremely bullishly positioned futures speculators out of their DXY futures long positions, but they still retain a fairly chunky net long exposure – this goes  especially for small speculators.

As an aside to this, speculators continue to maintain fairly large net short positions in the most obvious candidates, such as e.g. the Australian dollar, where a record speculative net short position is currently held. Not that we necessarily disagree with the fundamental thesis on the Australian currency, but the positioning has become quite extreme lately. A reaction seems likely.




Positioning in DXY futures: the speculative US dollar net long position has decreased due to recent volatility, but it remains at a historically elevated level nonetheless – click to enlarge.



One of the reasons why people have turned bullish on the US dollar is probably also its longer term chart – in the late 1980s to mid 1990s, its gyrations were very similar to those seen since 2008, and this was also while coming out of a period of extremely low rates in the wake of the S&L disaster (also, the yen gyrated wildly at the time). However, there is no ironclad law that says that the future must develop in a similar manner.

At the very least we would expect that the recent extremes in the bullish consensus will result in medium term weakness (we are agnostic regarding the short term).

Among the reasons that might trigger such a trend could either be the sudden death of the 'taper' idea due to unexpected economic weakness, or the realization that the damage inflicted by 'QE' already will play out with a lag, regardless of any 'QE tapering'.



DXY,LTThe US dollar index, long term. The similarity of the gyrations in the late 80s/early 90s to today's are notable. But that is not a guarantee that the outcome will be similar, or that there cannot be a bout of medium term weakness – click to enlarge.



Lastly here is a look at the EM equities positioning of fund mangers taking part in the Merrill survey – the 12 year low in this data series strikes us as quite notable as well.



merrill survey-EMEmerging market equity exposure according to the ML fund manager survey: a 12 year low – click to enlarge.




A number of medium to long term contrarian opportunities seem to be shaping up. Having said that, many of the trades that appeared 'obvious' have actually worked quite well in recent months (one need only remember the yen, where sentiment and positioning extremes failed to stop a large decline from unfolding). So perhaps alert traders should wait until they see the 'whites in their eyes' as the saying goes. On the other hand, even that trend – namely that all the obvious trades are seemingly 'working' –  is bound to change again.





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One Response to “Notable Consensus Extremes”

  • This is an excellent analysis which gets to the heart of why contrarian investing works. Regardless of the fundamentals, any extremely overcrowded trade will inevitably fail. That’s because the financial markets ensure that the greatest number of participants lose money.

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