Just as expected, the S&P500 continued to bounce up last week, for a total gain of 3.75%. But volume–as has been typical with weeks that rise–fell off, giving the rise less validity. The VIX (or fear) index slumped to three month lows and not far above the 2010 lows reached in April. This fall off in the VIX reading is a sign of growing complacency, complacency that may not be warranted.
The macro data were not uniformly grim–for a change. Personal income was lower than expected; personal spending was slightly higher. The result: the personal savings rate dipped in July. ISM Manufacturing was better than forecast; ISM Services was worse. Initial jobless claims were slightly higher than the consensus estimate; and total continuing claims (regular, extended, and emergency) has been hovering around shockingly high 10 million for several months now. Factory orders were worse than expected. The headline unemployment rate rose to 9.6%. While “reported” nonfarm payrolls fell 54,000, when the loss of 114,000 census workers and the addition of 115,000 birth/death fantasy workers are factored out, then about 55,000 jobs were actually lost in August. Almost three years after the recession began, the US economy is still losing jobs. Not good.
A few months ago, The Economist and more recently, Citibank put forth an argument that the Cult of Equity, that has dominated the investment world for over 50 years, is coming to an end.
What does this mean? After decades when pension funds, endowments and other institutional asset managers shifted their allocation to equities to well above 50%, the reverse is now starting to happen: these managers are shifting back into bonds and out of equities.
Why is this happening? For starters, two market meltdowns over the last ten years has spooked even the most risk-tolerant investors. The great moderation in business cycles is now shattered, and volatility has skyrocketed. Second, the baby boomer demographics are driving retiring investors to shun riskier assets (ie. equities) and seek out more reliable income generators (ie. bonds), especially as more defined contribution plans (eg. 401k) shift the return risk to individuals and away from employers.
So it is no surprise that, as of last week, equity mutual funds have suffered from 17 consecutive weekly outflows, according to ICI.
More ominously, there is much more potential selling to come. If institutional equity allocations revert back to their pre-1959 levels (about 20% of assets) then–in the US private sector pension space alone–almost $2 trillion of equities could be sold.
If Japan is a model (and it’s becoming an accurate model for the US for many other aspects of the economy), then the equity allocation could drop to less than 36% of total assets (from over 55%). This would translate to almost $1.5 trillion of stock liquidation.
So even if the US economy doesn’t fall apart again over the next six months, it’s highly unlikely that investor will rush back into the stock market–especially when trillions of additional dollars will be needed to fund the US government’s massive and unending budget deficit.
When you follow this money trail, it strongly suggests that stocks will be struggling for many years to come.