JPMORGAN: A massive universe of investors is still loaded up on stocks - here's why that could mean the worst of the sell-off is yet to come
- A vast group of investors that includes pension funds and sovereign-wealth funds remains overweight stocks, even after recent volatility, according to JPMorgan strategists.
- This suggests they expect the market to recover from its recent losses.
- At the same time, JPMorgan says it could leave stocks vulnerable to even more downside than recently witnessed if these investors find sufficient reason to sell.
The roller coaster in stocks this month has not been violent enough to push the largest group of investors out of the market.
So-called end investors like endowments and pension funds - both of which manage other people's money - still hold a big overweight in equities, according to global market strategists at JPMorgan.
This demonstrates their conviction that stocks will soon recover their losses. Viewed differently, however, it shows that there's plenty of room for stocks to fall to if these investors identify an adequate catalyst to flee the market.
"This big equity overweight poses further downside for equity markets from here if negative momentum and sentiment eventually induce real money investors to capitulate," JPMorgan's Nikolaos Panigirtzoglou said in a recent note to clients.
Panigirtzoglou had pointed out earlier in October, before the worst of the recent sell-off, that retail traders who manage their own money were also heavily exposed to stocks. He came to this conclusion after studying households' allocation to stocks and the high levels of margin debt held by traders.
Hedge funds have also maintained their overweight to stocks amid the sell-off.
But Panigirtzoglou has placed a specific emphasis on end investors as a "broader universe" of traders whose exposure to stocks poses a downside risk to the market.
Overall, non-bank investors have a 44% allocation to stocks, according to Panigirtzoglou - at the higher end of their rationing since the 2008 financial crisis.
Their allocation to stocks is in contrast with their holdings of bonds and cash. According to JPMorgan data, non-bank investors hold 37% in cash as a share of their combined holdings of bonds, stocks, and cash. That's lower than both the longer-term and post-crisis averages, as the chart below shows.
The estimated dollar figures of their holdings confirm their preference for stocks over the relative safety of cash and bonds. According to JPMorgan, non-bank entities hold $27 trillion in bonds, $53 trillion in cash, and $62 trillion in equities.
What this rationing implies is that stocks would be vulnerable to more losses if end investors find sufficient reasons to change their overweight allocation in stocks.
Besides investor allocation, another key indicator confirms that investors still believe in this bull market. It's the Arms Index, which compares advancing and declining stock issues and trading volume as a gauge of market sentiment.
Even after last week's selling, it didn't climb above the threshold that indicates panic. The implication from this indicator, and from JPMorgan's data, is that the worst could still be to come for equities.