Fast and furious rally risks triggering the Sell signal

The markets rallied so fast in November that bullish investors risk pushing the needle towards the “Sell” signal, according to Bank of America’s indicator.

The “Bull & Bear Indicator” jumped to 5.8 last week from a previous level of 4.7, getting closer to the extremely bullish area that starts at 8 and triggers the “Sell” signal. The BofA fund managers “cash rule” is also close to a sell signal, with cash holdings low at around 4%.

There were remarkable capital movements in financial markets in November, with equity funds having received record inflows of $122 billion, according to Deutsche Bank Research.

Inflows into cyclical and value funds — the Cinderella of funds before news of efficient vaccines emerged — surged last month. But this does not mean that growth funds and those with a environmental, social and governance (ESG) focus suffered: they also saw “steady and strong inflows”, the report said.

The largest recipient of inflows over the past four weeks was the US, with $50 billion, followed by funds with a broad global mandate, which saw $39 billion pouring in.

Flows into emerging markets, totalling $25 billion during the same period, went primarily to Asia and China.

Despite the strong rally in equity indices in Europe (or perhaps due to it, as investors wanted to take profits), European equity funds saw redemptions worth $2.4 billion in the past four weeks.

Turning to bond funds, the risk-on sentiment meant that investors redeemed $10 billion from government bond funds and instead put $12 billion into emerging markets bonds, $6.4 billion into investment grade corporate bonds and $5.8 billion into high yield bonds.

The Bull & Bear Indicator is moving fast towards extreme bullishness. Source of graphic: Bank of America Research

No wonder investors are having a party. Bank of America has pulled together the data for fiscal and monetary stimulus in various countries across the globe, and the results* are staggering:

  • Fiscal stimulus total: $12.4 trillion
  • Monetary stimulus total: $7.6 trillion

* Totals calculated by me on the basis of the BofA data, which quotes information from Bloomberg. These are just estimates.

With global GDP worth $87.6 trillion in 2019 (according to the IMF), fiscal and monetary stimulus to deal with the Covid-19 pandemic amounts to almost 23% of the world economy.

A fragile mesh of debt

However, a lot of this stimulus, and in particular the fiscal stimulus, is made up of loans. These will have to be repaid some day, and the debt situation is already looking fragile.

“The mesh of schemes and subsidies providing loans, guarantees, and—in Europe especially—subsidising labour will be gradually removed as recovery gathers pace and governments seek to remedy fiscal deficits,” a recent report by S&P Global shows.

“This is likely to put pressure on companies with unsustainable capital structures, prompting insolvencies or restructurings.”

It is fair to say this will probably not happen right away, so the rally may still have a way to go yet. It seems that bad news on jobs turns into good news as investors believe more stimulus is coming, and good news on vaccines just adds to the general feeling of optimism.

December may turn out to be another good month for stock markets, as investors are cheered by the winter holidays and hopes for a better year, and then we might see the January blues setting in.

However, the longer-term prospects may not be that bad. Yes, there is a lot of debt and it will have to be dealt with. But consumers will be coming back to areas that were previously off-limits – bricks-and-mortar shops, leisure, restaurants, bars – and new or revamped businesses will open.

Covid-19 has already changed life as we know it, and we are probably only at the beginning of the transformation. Like with every upheaval, this one too will be full of opportunities.

Even if the Sell signal is triggered in the coming weeks, over the longer term it may prove to be just another opportunity to pick the winners of the transformed economy.