Over the weekend, I wrote a fun vignette about some Sunday plans I had and I drew a parallel to markets.
Here’s how my Sunday morning unfolded, for those who might have missed it:
It’s Sunday morning as I write this and there for about 15 minutes, I had designs on cramming my woefully out of date MacBook Air into my trusty Alleretour Messenger 34 (which has been subjected to an obscene amount of abuse considering its pedigree) and trudging the two-ish miles to a brand new park local officials decided to install next to one of the only public beaches on the island.
I like parks and I wish all the beaches here were free for visitors because even during tourist season, this place isn’t exactly Miami. That is, it’s not like there are more people than beach space (even in July and August), so it’s not entirely clear whether charging people for access is even profitable, let alone necessary or desirable.
Anyway, my only qualm with this new installation (which amusingly features one of those fountains that kids can run around in despite the fact that there are almost never any small children here) is that it’s right next to one of my favorite local seafood shops which is itself hidden in the back of a grocery store (I’d tell you the name of the grocery store chain, but that might be one hint too many).
This grocery store is a real throwback. Walking in there is like a time warp. I’d say it satisfies my desire to feel nostalgic for something, but that wouldn’t be quite accurate because I’m literally not old enough to be nostalgic for a time when this place would have been considered some semblance of modern.
My overriding concern is that the decision to install this park is the first step towards modernizing everything in the cul-de-sac where it’s located. If that ends up being the case, well then you can kiss my beloved Andy Griffith-style grocery store goodbye. Today was going to be a reconnaissance mission, of sorts.
Then it got hot. And the morning breeze that, just an hour ago, was wafting across the back deck and carrying both the steam on my coffee and the smoke off my morning cigar out to sea, has given way to a balmy, humid quagmire that pretty much rules out walking anywhere comfortably.
The market parallel is simple: after breezing to record highs in January on the back of a veritable avalanche of retail investor inflows, optimism about the implications of the tax cuts in the U.S. and a generalized sense among investors that we were entering the fabled “blow-off top” phase of the long-running rally, equities’ trek to higher has been an exceedingly arduous affair – uncomfortable, halting and reminiscent of what I imagine my walk to the fish market would have been like had I chosen to embark on a two-mile hike on a breezeless, humid island morning.
There are myriad factors that account for the tough time stocks have had since the halcyon days of January.
“Investors’ exposure to equities is still relatively low,” Marko Kolanovic wrote last week, in his latest missive, before adding that “systematic strategies de-risked on account of the high realized volatility in Q1 and discretionary investors de-risked on account of various macro fear narratives (including inflation, 10Y >3%, trade war with China, Syria/Iran, Emerging Markets, PMI slowdown, Italy, dollar, quantitative tightening, etc.) and, despite the recent rally, have not meaningfully re-risked.”
Playing out in the background is a tug-of-war between credit (which has repriced wider) and other markets which, as Deutsche Bank’s Aleksandar Kocic wrote on Friday, “seem to be pricing the recent developments as transient.” Kocic characterizes this as the “bifurcation of risk premia” and one simple way to visualize it is simply to plot IG spreads against FX vol.
Well in the latest edition of the popular “Flows and Liquidity” series, JPMorgan’s Nikolaos Panigirtzoglou says something similar to the point I made over the weekend about the path higher having become something akin to a long, sweaty trudge in hot weather.
“Investors have been struggling to make money this year”, he writes before noting that “following a strong start to the year, investors gave back their January gains during February and March, were flat in April [and while] May saw some relief, especially for hedge funds, even after May’s gain, hedge funds overall were up by only 1.4% to the end of May.” Here’s the breakdown:
Panigirtzoglou goes on to detail the extent to which CTAs and other systematic strats have underperformed – an assessment which I’m certain won’t be welcomed by the quant community. To wit:
Quant funds suffered by more this year given the lack of strong trends in most markets. CTAs were down 4.5% until the end of May according to HFR, while Risk Parity funds were flat with a very small gain of only 0.4%. In addition, Artificial Intelligence (AI) funds were down by almost 3% up until the end of May according to Eurekahedge. Discretionary hedge funds have outperformed their Quant counterparts in both Macro and Equity spaces. In the Macro space, Discretionary Macro managers were up by 0.7% during the first five months of the year vs. a loss of 4.5% for Macro Systematic Diversified funds. In the Equity space, Equity L/S hedge funds were up by 2.3% during the first five months of the year vs. flattish return for their Quant counterparts (i.e. Equity Quantitative Directional and Equity Market Neutral funds).
What accounts for this relatively lackluster performance among institutional investors? Well obviously flat equity and bond markets (i.e., flat benchmarks) are a factor and the overarching point of JPMorgan’s analysis is to say that 2018 is starting to look a lot like 2015.
“2018 to-date looks similar to 2015 in terms performance [and] also in terms of how poorly Quant funds such as CTAs and Risk Parity funds did vs. Discretionary funds and how poorly EM hedge funds did (-3.3% in 2015) vs. those investing in DM markets,” the bank continues, before adding that fund flows and turnover resemble the conditions that persisted three years ago as well.
You can see the sharp fall in inflows in the following chart:
And as far as turnover, JPMorgan spells out what the problem is (spoiler alert: it’s uncertainty). To wit:
Market turnover tends to be high when uncertainty is high as institutional investors tend to reshuffle their portfolios. Negative growth revisions coupled with political and policy risks including the Italian crisis and trade war risks are creating a lot more uncertainty this year relative to last year. And this was also the case in 2015 when the global economy was in a state of flux, not only due to the collapse in commodity prices and negative growth revisions but also due to policy uncertainty in EM and in China.
JPMorgan’s takeaway: this could end up being a “tricky” year to make money.
Or, as I put it over the weekend, “there are a series of dynamics that may serve to make your trek a halting, unpleasant affair.”