The BofA sentiment indicator has fallen to 3.4 from 3.9. For long-term investors, a reading between 1.5 and 4.5 is a contrarian buy indicator. Risk, volatility, and forward returns are historically elevated at these levels.
A Quick Summary of Flows
For the impatient among us, hereโs a quick and dirty rundown of the key highlights Iโll cover in this issue:
$46.3 went to cash (most since mid January), $1.9bn to gold, $5bn from equities (first outflow in 10 weeks), $10.6 to bonds.
Biggest outflow from Emerging market bonds since Marโ21 $3.1bn $EMB
Largest MBS outflow since Marโ20 $1.6bn - (taper front-run?) $VMBS $MBB
Biggest outflow ever from European equities $6.7bn $VGK $FEZ $EZU
Biggest outflow ever from financials $3.5bn $XLF
Largest REIT outflows since Mayโ20 $1.1bn $XLRE
Largest Energy inflow since Marโ21 $2.4bn $XLE
Largest inflow ever to materials $4.1bn $XLB
Past and Present? 1973-1974
Performance by asset through โ73/โ74, Oil & War Shock/Stagflation Regime
The oil shock of 1973 and the Yom Kippur War hit equities hard, with only commodities out-performing inflation. The #SPX had a -40% drawdown-from-peak.
Tech, consumer discretionary, banks, and small caps got hammered in the 70โs. The Fed engaged in tightening but oil prices did not reverse course, but remained at structurally elevated levels despite hostilities cooling off.
The bear market/recession only ended when the Fed reversed course, after slashing the Fed funds rate to 3% (from 14%).
What about 2022? We have a Russian war in Ukraine and peak inequality in the US (and worsening) off negative wage growth. More countries are adopting isolationist postures toward the global economy, and intervention is rising. Weโve seen less confidence in global financial systems, with more sanctions, confiscations, and tariffs. If history rhymes, this could mean a new era of inflationary boom/bust cyclicality.
Weโve had a reversal in inflationary vs. deflationary assets, commodities vs bonds, Saudi vs. Chinese tech, and value vs growth.
Major themes of the 2010โs vs 2020โs:
Euro producer prices were up 30.6% YoYโฆ pre-invasion. Commodity prices are soaring. Where have we seen this before? 1915? It doesnโt even fit on the chart.
The 1970โs: Misleading or Bellwether?
The 1970โs may provide an easier analogue. However, the macroeconomic environment has shifted so drastically, and the Labor/Capital line doesnโt even look like the same planet anymore. As such, I expect workers/labor to suffer more in 2022. As corporations notched record profit after record profit, thereโs still talk about โrecoveryโ, and the Fed hasnโt even tapered or raised rates. The government hasnโt passed a single bill in favor of tax-paying citizens in recent memory. Without getting too political here, itโs a bit silly, as politicians are supposed to represent us, the taxpayer. Since 2010, theyโve represented concentrated money and corporate interests instead.
All in all, I find thisโฆ Kind of ridiculous? Personally, Iโd like corporate America to give me a refund. A $20k check would be quite nice, and more in-line with what corporations are receiving, compared to the $600/$1200 hand-outs from the treasury. Anyway, letโs just remember that the governmentโs outlay on social programs is minimal, as are taxes on corporations. This sits in stark contrast to the 1970โs, and I find the two regimes difficult to compare, despite sharing many similarities in capital markets. Society, taxation, regulation, and governance have all changed dramatically.
With that in mind, letโs take a look at the 1970โs. I do worry that this is a scare tactic. Wall Streetโs media arm seems to exist for the sole purpose of manipulating individual investors. Expect a lot of fear, uncertainty, and doubt. Try to remain optimistic and certain that you will stick to your plan!
Cutting to the Chase: A look at the 70โs
Soโฆ what happened AFTER oil peaked in the 70โs? Commodities canโt keep rising forever like equities.
Yeahโฆ COPPER did fine. Everything else did awfully. Banks and utilities got obliterated. Cash performed better than bonds and equities. This is pretty rare.
My Thoughts
When I look at the 70โs, I see the inflation and the hit to equities. But I also see something else. This is one of the times when boomers (and their parents) were able to accumulate massive amounts of FUTURE wealth. Equities traded at cut-rate prices. Investing in โ73-โ74 was, arguably, one of the best times to invest for the future.
Investing for the short-term? Not so great! The problem is always the same: nobody knows where the bottom is. Nobody knows when the market will start ramping. Nobody knows if that ramp is a false bottom. Iโll always advocate for staying in the market and repeatedly buying.
Thatโs a ridiculously scary chartโฆ but the general direction is โupโ. One of the easiest and most-damaging errors an investor can make is to suddenly go to cash. Staying invested and optimistic is the only reality-based approach to bear markets.
This too shall pass. I donโt know how it will, I just know that it will. Never bet against America. We always find a wayโฆ. and we usually find a way to make it out ahead of other nations. The US is, by any measure, an unrivalled force in global capitalism, and home to the most-powerful and valuable corporations with the highest profit margins and most stable business models.
Over any 30-year period, equities have always beaten inflation. Bonds have not done so. Weโre not even in a bear market here. We could get there, but I donโt think anybody truly knows.
Return Landscape: Flashback to the 1970โs
Each week Iโve been sharing a relevant โasset return swatchโ, to help visualize what performed well under prior or current economic cycles. For the period of 1965-1979, which started off with the โGo-Go Yearsโ, awful glamour stocks/tech led in โ65-โ67. I wonder whoโs left. $IBM?
A truly incredibly book. The first โreal wall streetโ drama written contemporaneously. Before โWall Streetโ (1987) or โThe Big Shortโ (2010), there was โThe Go-Go Yearsโ by John Brooks. Guess who wrote the forward? The same man who wrote โThe Big Shortโ and โLiarโs Pokerโ, Michael Lewis.
Of note: nearly every asset class was outpaced by inflation from 1973-1979. What did well? Nothing. Energy did alright, I guess. This was one of the rare times where the S&P 500 wasnโt from Lake Woebegone, and was merely average, rather than above-average. (The #SPX almost always returns a bit more than the average asset class. Heading into the 1980s, the #SPX went on to smash every single one of the listed asset classes here.)
โDoes this mean I should buy *points at a box* this thing here?โ
โUhh.. what? No.โ
Seriously, this is for educational purposes. Sector compositions were wildly different in the 70โs and with the exception of bonds/inflation, basically every sector has undergone seismic shifts.
As of August 2020, the #SPX sector/sub-industry breakdown went something like this:
As shared on Twitter yesterday, the composition of the US market has changed considerably over time. You can see the entire visualization below. (If tech looks small, itโs because $AMZN $GOOG and $FB arenโt considered โinformation technologyโ.)
You probably will need to zoom this one and pan around, but I guarantee you, itโs quite interesting.
What Iโm Seeing/Hearing
Sentiment has shifted in favor of US equities following the Russian invasion. GDP estimates show a consensus contraction in the US from 3.7% to 2.5% in 2023. In Europe, a much steeper decline to 2.5% from 4%.
Everyone seems to be bearish.
Weakness in lead indicators of the end-of-QE bear market past 12 months
Canโt catch a bid: EM debt/Chinese credit, Chinese tech, biotech, despite lower yields. This can indicate early liquidation or an anticipation of geopolitical dislocation to financial and FX reserves.
Credit spreads are widening, volatility is heightened, and conviction in โ2022 longsโ is evaporating, such as banks. $JPM lost nearly all of their gains from the past two years this week.
Hope is Not Lost
EPS estimates were 8.3% for the US and 4.7% in Europe. Looking forward to 2023, while we could see some moderation in estimates, things donโt yet look to be in poor condition.
In fact, US-domiciled corporations are on far better footing than they were in the 1970โs, and I think this has been missed by many analysts. Flows would seem to indicate sentiment is blowing this way already.
The 1970โs had wide-ranging social programs, an incompetent and handcuffed Fed, and US corporations had to answer to the public. This has changed over the past 50 years, and corporations have nearly no responsibilities to the republic, minimal taxes, regulations and oversight are virtually non-existent, and the markets seem oversold.
Flows
As mentioned earlier, we saw the biggest outflow from EM debt since March โ21 and the biggest outflow EVER from European equities.
Financials had their largest ever outflow, while Materials had their largest ever inflow.
BofA Private Client flows: Bank loans, IG, growth leading
After loans/IG/growth: munis, EM debt, staples, materials, and energy saw the highest ETF flows as % of AUM from GWIM clients. Equity allocation stands at 64.2%.
BofA private clients are holding an average 17.3% allocation to debt, and 11.7% in cash, both below the LT average, although cash has picked up in January and February.
ETF holdings have continued to rise as a % of AUM for BofA private clients. Only 16% in ETFs? Glad Iโm not a BofA client, their returns must be absolutely atrocious.
But I digressโฆ This is hilarious on the face of it. Look at the chart on the right, above. Do BofA private clients have enough beta in their portfolios with their top-10 holdings? What on earth are they even holding? I really donโt want to know. Probably $LCID and other weird boomer memestocks. Yeah, I said it. BofA private clients arenโt very bright. They do have a lot of money, though.
Weekly Equity Flow Summary
Equity funds also suffered their largest weekly outflow on record, based on data going back to 2004, as geopolitical risk scared investors out of their holdings.
Global EM debt funds had their worst weekly outflow in 51 weeks. Commodity funds had strong inflows and have gained 2.5% in AUM YTD.
ICYMI: HFs and Institutions Bought The Dip
The #SPX had a volatile couple of weeks.
For the week of 2/21-2/25, BofA saw aggressive dip-buying in equity client flow trends. Itโs worth noting that all three groups: Institutional, Hedge Funds, and Private Clients were all buyers, led by institutions (who were net sellers all year).
Small caps were sold (first time in nine weeks), and large caps were bought (first time in three weeks).
ETF flows have looked โhealthyโ. Healthcare had itโs best week for inflows at the end of February, too. (Week of 2/25 here, still).
Corporate buybacks accelerated relative to the prior week but were the second-lowest of any week YTD. Cumulative corporate buybacks amounted to 0.05% of the S&Pโs market cap, and are tracking above 2021 levels (0.03%), but below 2019 levels (0.06%) for this part of the year.
Last week, I went in-depth on Equity and FI flows for the week of 2/25, as it was the first time in 2022 that we saw HFs and Institutions buying instead of selling. I believe this marks a โsea changeโ. While we canโt see โthe bottomโ, HF and institutional buying could help set a โfloorโ of sorts for equities.
Read more here:
2022 Returns
So, what about this year? Well, most everything is down except for energy and commodities.
Hereโs how it stands, with Russian equities down -60% as of March 2nd:
โThe Overbought & Oversoldโ: Ranked deviations from 200dma in USD:
Fixed Income Flows: A Deep Dive
Risk assets have remained under pressure as geopolitical risks rise. For IG, HY, and EM debt/equity funds, outflows are going through their worst period since March 2020.
Outflows were initially caused by CB-related uncertainty, but risk-assets flow trends have been pushed deeper into negative territory as geopolitical tensions escalate.
Over the past week, high-grade funds suffered a seventh weekly outflow in a row. High-yield funds suffered another outflow last week, the largest since March 2020.
High-yield funds have seen 4% outflows YTD.
High-yield ETFs also had their biggest weekly outflow in a year. Last weekโs 4-week average was -$1.9bn. The blue line represents the 4-week average.
High-yield monthly inflows/outflows, 2010-2022 with quarterly average (blue line).
A breakdown of HY funds by US/Euro/Global regions shows each getting hit by outflows, with the latter underperforming.
Government bond funds saw an inflow as FI investors sought safety. Money market funds recorded an outflow, which makes 7 of 9 weeks this year for MM outflows.
As a whole, fixed income funds had their eighth consecutive weekly outflow, and are currently experiencing the worst start to any year since 2009.
4% of AUM has fled high-yield funds in 2022, almost as bad as 2018.
1.7% of AUM has left high-grade funds over the first nine weeks of 2022.
High-grade monthly inflows/outflows w/ quarterly average (blue line).
FI outflows steepened.
Iโve been recommending exposure to energy, as well as metals/miners for a few weeks. As many have seen, returns since then have been astronomical. As of yesterday, it seems some of FinTwit has finally noticedโฆ I just worry theyโre a bit late to the show.
On March 1st, I wanted to highlight $CVX, which you can see here if youโd like:
On March 2nd, I wanted to shine a light on $COP, another large US oil major.
Iโm currently holding some energy funds, but have already begun scaling back my exposure, especially direct exposure, and using energy equity funds and a diversified basket of commodities ($VDE and $PDBC).
While itโs been a few weeks since I first posted it, I posted an updated โGlobal Capital Cyclesโ sample portfolio to share some ideas.
While this portfolio leans heavily on $VGPMX and $VGELX from Vanguard, or $FFGCX and $FSENX, as well as a dash of $XME, it is possible to create a similar portfolio using ETFs if youโd like. These are risky and volatile asset classes, and are not suited for long-term investors, but is a valid way to lean into global capital cycles. Vanguard now has a fund named after this concept.
$VGPMX hasnโt delivered much return in the past, but in 2022, itโs one of Vanguardโs best-performing funds, along with their energy funds.
Fidelityโs $FSENX and $FFGCX are also up 10-25% this year, but have much higher expense ratios and the holdings are not quite as fitting as Vanguardโs. I will always recommend Vanguard first.
What about Exxon? $XOM Analysis/DD
I wanted to take a deeper look at Exxon $XOM, as Iโve already touched on Chevron $CVX and Conoco-Philips $COP recently. So, here we go.
Exxon has had free cashflow growth of 5x, which differentiates it from peers. $XOM telegraphed their outlook in Dec โ21, its 2022 strategy update filled in some gaps on critical milestones that underline confidence in topline cashflow and FCF growth that sets $XOM apart from industry peers.
$XOMโs base case assumes that at flat $60 Brent, it can generate excess free cash of over $100bn between 2022-2027. At current strip prices this is significantly higher. Management is treading carefully on affirming use of cash, but stepping up cash return to shareholders is looking increasingly like a question of when not if.
Exxon has capacity to buy back 30% of its current market capitalization over its plan period to 2027. I expect Exxon to reach $105+.
In 2016, Exxonโs functional structure featured nine companies. In 2022, theyโve simplified, using a โsolution-led structureโ. Now thereโs only three! Whoa!
Buoyed by a strong suite of projects well on their way to development, a potential increase in valuations by offsetting increased activity is material.
$XOMโs project queue is quite good, and their work in Guyana seems to be their best shot, but CV19 has tempered managementโs outlook, along with third-party execution issues (Chevron Tengiz, Gorgon).
Iโd consider it likely that $XOMโs gross production capacity reaches 1.2 to 1.25mm bpd within 5 years; (gross) production included in its planning assumption classify Guyana at โmore than 850,000bpdโ. The difference is the potential declines on earlier development phases. The scale of the resource appears to be well over 10bn boe, holding production essentially flat for an extended prior, based on disclosures from $XOMโs 30% partner, Hess. See below.
Guyana: 1.25mm bpd of capacity (growth extends beyond 2027, to 10 boats)
However, โgreater than 850,000bpdโ seems to be a conservative estimate compared with 1.25mm bpd of capacity. I think Exxonโs guidance has been cautious and conservative, with production outlooks of 4.2mm boepd (or a 2% growth rate from 2019, assuming 230k boepd of asset sales that has upside with its proposed exit from Sakhalin.)
BofA agrees:
I think Exxon is getting better and better. FCF capacity is expanding faster than peers (5x over six years is amazing). Share buybacks could amplify per-share impacts, and absolute expansions in FCF is one of my favorite definitions of value. XOMโs portfolio outlook seems materially undervalued at current strip prices.
DCF analysis on $XOM: $110?
Earnings changed reflect updated mgmt guidance:
So, based on $65 brent and $61.50 WTI long-term, $3 Henry Hub NG, then $110 per share is possible, with $105 seeming like a conservative outlook. This includes a WACC of 6.8%, based on risk premium and 2-year weekly beta.
Risks include oil and gas price and margin environment, significant delays to new upstream projects which are critical to $XOMโs growth prospects, and an inability to capture the price movement due to cost pressures (OPEX, CAPEX, and taxation). Upside risks would include higher prices for oil and gas than assumed above.
This is just my opinion though, and I might be wrong. Youโll have to pay a financial analyst to get any sort of certification on research. Sorry!
Wrapping Things Up
In summary, the market is looking a bit weak, but an uplift from HF/institutional inflows could be changing the tide and equities may be finding a bottom. Flows havenโt been supportive ex-US yet, and with Russia on the warpath, weโll need to wait and see how EM/DM markets are impacted. Itโs quite possible that recent outflows from DM/EM have been an overreaction, if not in the short-term, then certainly in the long-run, as DM trades at a very steep discount to US equities, which still remain expensive vs. the rest of the world.
Last night, as a thought experiment, I wondered: โwhere would the #SPX be *without free trading*โ. By best estimate was somewhere around 3600-3800, assuming a 5-6% YoY growth for the #SPX without any free trading.
In short, I highly doubt the #SPX will go below 4000, and only with a heavy amount of short pressure and a domino effect in complications stemming from the war in Ukraine.
When the market sell off in a โbad wayโ, I have deposits ready to go, and have been a net buyer of equities all year. This wonโt change, even if the #SPX keeps dropping. In fact, Iโll probably take out a small personal loan or a 0% APY credit card to ensure Iโm able to buy as much equity on the cheap as I can. This is where wealth is accumulated at a discount, and why I recommend weekly/bi-weekly and automated buying of a diversified portfolio of mutual funds.
Thanks to everybody who gave suggestions on Twitter for subject for me to cover, and Iโll see what I can put together going forward to answer more questions or cover more ground.
I hope youโve enjoyed all the pretty charts and the $XOM deep dive.
Wishing you and your loved ones a safe and happy weekend!
โAvery
P.S. In case you missed it, Goldmanโs Exchanges Podcast had some interesting thoughts on the effects of the Russian war in Ukraine on the global economy and markets.
gr8 post