fear vs. greed?: we’re deep into fear

A short while ago I got an email containing an analysis of the current sector positioning of US mutual funds and ETFs. I can’t find it at the moment–who knows why–so I can’t attach a link to the underlying analysis. The conclusion, though, was that at the end of June the typical equity ETF/mutual fund was in the most defensive position it has been since the middle of the financial crisis in 2008. This means: underweight tech; overweight defensives (meaning steadier earnings during bad times) like healthcare, utilities, consumer staples; and a larger than normal cash position of 6%+ of assets.

I think this is important, for two reasons:

–2008-09 was the worst period for the world economy over the past century, other than during the Great Depression of the 1930s. Way worse than the internet bubble of 2000. 2008-09 supplanted the economic collapse of 1973-74 as the most horrible period in the working careers of anyone then active on Wall Street. Certainly worse than anything that is happening in the world right now. Put a different way, fund managers seem to already be betting that the current situation will go south from here–and to have already cleared the decks of what they regard as their most economically-sensitive names. Arguably, then, selling pressure from funds will only/mostly result from investors redeeming their shares. Even then, my guess is that selling will try to preserve the current portfolio structure rather than act as a tool to make the portfolio more defensive (or aggressive). If so, redemptions will likely hurt the (overweight) defensive sectors more than the (underweight) aggressive ones.

–early in my career I encountered Robert Farrell, the technical analyst from Merrill who was the most important brokerage house strategist of the late 1970s – early 1980s. His most important tool was his access to the leading portfolio managers of the day, who found him very helpful as a sounding board for discussing and refining their investment strategies. From these conversations, Farrell was able to form a consensus view. He would confirm through trading data that this view had been implemented in portfolios …and he would then recommend to his clients that they do the opposite. His advice/strategy was uncannily accurate for a long time. Eventually, big-time portfolio managers figured out what Farrell was doing, and (my conclusion, because that’s what I would have done) began to lie to him about their actions and plans. He then lost his golden touch and faded into obscurity.

My conclusion: becoming more defensive today makes sense as a betting strategy only on the belief that economic circumstances are going to be worse than the consensus expects–a consensus that’s already making a very big bet that bad stuff will continue to happen. My hunch is I’ll be better off rooting through bombed-out tech names using value-stock asset-value criteria.

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