Lack of Corporate Hubris Means Elongated Cycle

1) Credit Suisse data shows that US pension funds have their lowest equity allocations in more than 30 years.

 

2) BofAML’s “Sell Side Indicator” highlights that Wall Street strategists continue to underweight equities in their recommendations.

 

3) ISI’s hedge fund survey suggests that hedge funds are neutrally positioned.

 

4) ICI mutual fund flows have been negative for US equity funds for more than two months.

5)As mentioned, S&P 500® high beta stocks are selling at their cheapest relative valuations in nearly 30 years.

 

More importantly, corporations remain uncertain, too Over-enthusiasm is typically a characteristic of the late stages of a bull market.  Analysts often focus on investor sentiment to determine if investors are over enthusiastic about stocks.  As noted above, the data strongly suggest limited, if any, enthusiasm for the broader stock market.

It is often equally interesting to look at corporations because corporate hubris typically drives decision-making in the real economy during the late stages of an economic cycle. Corporations’ budding enthusiasm as the cycle matures leads them to increase their operating leverage and raise fixed-costs.  Operating leverage generally increases firms’ sensitivity to the economy, and smaller changes in demand have a magnified effect on profits.  During a slowdown, increased operating leverage amplifies a slowdown in profits which then results in layoffs, plant closings, and the drawdown of inventories.

Corporations have been very conservative so far in this cycle regarding increasing fixed costs.  Although merger and lending activity has recently picked up, uncertainty over the past several years has curtailed the normal cyclical corporate hubris.  Such reserve could ultimately be a very healthy contributor to an elongated economic cycle. Chart 1 shows that corporations are not building excessive inventories.  This suggests that the quality of earnings is probably quite good, and decreases the probability of an inventory-led recession (i.e., producing goods that can’t be sold and hindering future production).            

Source: Richard Bernstein Advisors LLC, Standard & Poors’ *S&P 500 excluding those stocks in the GICS financials, utilities and transports sectors/industries. For Index descriptors, see "Index Descriptions" at end of document. 

Chart 2 demonstrates that corporations are not yet building excess capacity.  Property, plant, and equipment (PPE) growth, while above average, is hardly extreme and has slowed some.       

   

Chart 2:


               

Chart 3 highlights that corporations are not using excessive leverage to finance PPE and inventory expansion.  Debt/equity ratios seem quite conservative relative to history.           

Source: Richard Bernstein Advisors LLC, Standard & Poors’ *S&P 500 excluding those stocks in the GICS financials, utilities and transports sectors/industries. For Index descriptors, see "Index Descriptions" at end of document. 

RBA’s corporate motto is Uncertainty = Opportunity^SM.  Certainty implies risks not anticipated, and potential disappointment.  Uncertainty, however, often suggests higher-than-normal risk premiums and investment opportunity.A broad swath of data, whether focused on investors or corporations, continues to suggest meaningful uncertainty.  Accordingly, we continue to believe this may be an elongated cycle that still offers unrecognized investment opportunities.


INDEX DESCRIPTIONS:

The past performance of an index is not a guarantee of future results.

Each index reflects an unmanaged universe of securities without any deduction for advisory fees or other expenses that would reduce actual returns, as well as the reinvestment of all income and dividends.  An actual investment in the securities included in the index would require an investor to incur transaction costs, which would lower the performance results.  Indices are not actively managed and investors cannot invest directly in the indices.

S&P 500®:  Standard & Poor’s (S&P) 500® Index.  The S&P 500® Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad US economy through changes in the aggregate market value of 500 stocks representing all major industries. 

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