Almost a quarter of respondents to a March survey by Bank of America Merrill Lynch believe that U.S. stocks are overvalued. That’s the most since May 2000 and represents fund managers with more than half a trillion dollars in assets.
Even the rest of the fund managers that didn’t think the markets are overvalued are not waiting for the coming sell-off in shares. Big money players investing for pension funds and the financial sector have been fleeing stocks for the better part of a year. Selling by institutional clients of Bank of America set an all-time record of $4.1 billion during the week of June 15th. Hedge funds also dumped stocks with a net outflow of $500 million, the ninth consecutive week of selling.
But it isn’t just institutional players and money managers selling out of stocks. Household investors, with the memory of the 2008 collapse still fresh, are not waiting for another market crash to take profits and run.
Household investors are already positioning for a stock market collapse
Shares of the SPDR S&P 500 fund (SPY) have seen massive short-selling lately. The Wall Street Journal reports that investors have sold more than 298 million shares of the fund as of the beginning of July, a 27% increase in the amount of shares sold as of the end of March.
Investors borrow and sell-short stocks or funds to profit from a drop in values or to protect the rest of their portfolio from lower prices. The SPDR S&P 500 fund had 913 million shares outstanding as of the beginning of 2015, meaning that investors have borrowed a third of the shares to sell short.
Investors sold out of more than $16 billion in shares of the largest four exchange traded funds in April, after selling more than $30 billion in January. These four funds, like the SPDR S&P 500 fund and the iShares Russell 2000, are broad-based and good indicators of general sentiment in the market. Only commodity funds seem to be immune to the massive investor exodus. Funds holding commodities and precious metals saw inflows of $5.2 billion in April with the SPDR Gold Trust (GLD) alone gaining $1.3 billion in investment.
The exodus of investors from U.S. stocks is in preparation for higher rates and weaker economic growth. The Federal Reserve has been pumping money into the system, supporting asset prices for more than six years, but is now ready to start hiking interest rates.
The CME Group constructs market expectations for higher rates based on futures contracts for Fed Funds. The expectations are reported for each scheduled meeting of the Federal Reserve Board, showing the market’s expectation for Fed hikes in interest rates.
Rate expectations jumped after Fed Chair Yellen’s recent speech to the Greater Providence Chamber of Commerce, where she noted that rates will be increased this year if the economy continues on its present pace. Current expectations show a 57% probability that the Fed will have increased rates by at least 0.25% by its December meeting.
An increase in rates will remove several key supports from the market and investors are already positioning for the coming collapse. Higher rates decrease consumer and commercial demand for loans, directly slowing the economy. Increasing rates also make it more expensive for companies to fund massive share repurchase programs, which have supported stock prices through the recent investor exodus.
For those investors that have not yet covered their positions by selling stocks or hedging, there may not be much time left. Market sentiment usually turns six months before any expected catalysts. With rates set to increase before the end of the year, stock prices could collapse at any moment.
Shares of commodity funds will do well at first but could face significant selling pressure when overall market volatility increases. These funds are exposed to the same weakness in financial assets like stocks and other derivatives. The only real safety is in holding the real assets themselves – physical investments in gold, silver and other precious metals.