Goldman Answers The Big Question: Why Will This Market Not Roll Over And Die Already?

Ok, so obviously the question on everyone’s mind is this: “how is it that the bottom hasn’t fallen out for markets yet?”

The dollar had a miserable Q1 and far from presaging “reflation,” 10Y yields are flirting with disaster, where “disaster” means a deflationary rally below 2.25 exacerbated by short-covering and a return to market of Japanese buyers lured by a favorable FX backdrop and lower hedging costs. See how something doesn’t look right about this picture?….

Quick! Tweet something about markets to distract everyone. Here's one about the disconnect between bonds and stocks from BofAML: pic.twitter.com/dNohecJvZT

— Tracy Alloway (@tracyalloway) April 6, 2017

Turning to equities, we’ve seen almost all the “Trump trades” reverse on policy disappointment after policy disappointment. Someone won’t believe us about that, so allow us to show you the proof.

“Oops #1“…

“Oops #s 2, 3, and 4”:

(Goldman)

So what gives? Why does the broad equity market just refuse to roll over and die? Well, one popular explanation is the faith in “soft” data. So, amusingly, “faith” in “hope”. It’s like a double euphemism for “bullsh*t.”

Anyway, below find Goldman’s take on “Why the Equity Market Rally Outlived Faith in Policy Change.”

Via Goldman

After the surprise outcome of the presidential election, financial markets quickly priced expected action on a number of key campaign themes including ACA repeal, corporate tax cuts, infrastructure, deregulation, and trade restrictions. While we still expect a moderate corporate tax cut, market pricing now implies that confidence in these themes has largely reversed.

Many investors have raised two questions in response. First, why has the post-election rally in the equity market outlived faith in the policy changes that appeared to justify it? Second, if the answer is better growth news, can we really trust a pickup dominated by “soft” data?

We find that stronger economic data can largely account for the performance of the equity market since the election. Moreover, we find that the timelier soft data–captured by the soft data components of our CAI innovations index and our MAP surprise index–tend to be more important drivers of equity market performance than hard data, so that there is nothing unusual about the recent pattern.

We explored the link between the stronger data and the equity market. Specifically, we model monthly S&P 500 returns using either our CAI innovations index–which quantifies the “news” content in each data release–or our MAP surprise index. We test a number of linear models that regress monthly returns on either just a given index’s aggregate soft data component, both the aggregate hard and soft components of a given index, or both the US and global ex-US versions of the overall indices. We include the current month of data as well as a lag where helpful. The right-hand side of Exhibit 3 compares predicted returns from each model since the end of October with actual returns.

This analysis yields two conclusions. First, the simple models suggest that the strong economic data since the election can account for much or all of the strength in the equity market. Second, we also find that soft data tend to be more important drivers of equity market performance than hard data. This is not particularly surprising because the soft data are timelier, but it is a useful reminder amid investor concerns that there is something unusual or illusory about the recent response of the equity market.

So basically there’s nothing “unusual or illusory” about the recent equity market rally because it’s normal for the market to rally on “hope,” and “hope” alone.

How comforting.