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‘What A Difference A Quarter Makes’: Why One Bank Is Taking A ‘Glass Half Full’ Approach

"What gives"?

When last we checked in on Ajay Rajadhyaksha, Head of Macro Research at Barclays, he was recounting the story of an “exasperated” client who was frustrated that the market wasn’t providing anything in the way of dips to buy.

Here’s Rajadhyaksha recapping the call in the foreword to the bank’s Q2 outlook piece:

What, he asked, could possibly go wrong given strong global growth, non-existent inflation pressures, and a spanking new US tax cut? Sure, markets seemed too complacent, but there didn’t seem to be a plausible catalyst to shake that equanimity, especially given how calmly investors had reacted to event after event in recent years. How, he wondered, does one buy the dip if stocks only keep rising?

Well, one doesn’t. One buys the “prospective dip”, as I quipped in early January, a month during which euphoric sentiment manifested itself in a record percentage of Americans calling for stocks to rise in the year ahead:

Increase

 

As Ajay went on to joke in the same late March letter, “we haven’t checked back with him, but we assume market complacency is no longer his biggest concern.”

That was of course a reference to the February turmoil and also to what, at the time, was a burgeoning tech rout.

Since then, volatility has come back to Earth and the Nasdaq has hit fresh all-time highs along with the Russell 2000. But it’s been something of a tough slog.

“Investors have been struggling to make money this year”, JPMorgan’s Nikolaos Panigirtzoglou recently wrote, underscoring my characterization of the road higher for U.S. stocks as an “exceedingly arduous affair – uncomfortable and halting.”

“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,” Panigirtzoglou went on to say, in a note dated earlier this month.

So where do we go from here? Well, that’s always the question for markets, isn’t it?

For their part, Goldman was out on Thursday upping their EPS forecast for the S&P, but not their price target, reflecting limited scope for multiple expansion.

Wells Fargo recently suggested that while you might be tempted to “run for the bunker and grab all the cash & canned goods you can”, you might be better served to stick around.

That brings us to the latest global macro update from Barclays which clocks in at an “impressive” 72 pages. What follows is the opening letter to the piece, penned by the above-mentioned Rajadhyaksha who is taking a “glass half full” approach going into the back half of the year.

Via Barclays

What a difference a quarter makes. Three months ago, investors seemed skittish about every headline. Markets reacted badly to mild signs of wage inflation: bonds sold off, equities plunged, and VIX ETFs blew up in spectacular fashion. After a year-long hiatus, financial market volatility seemed to be finding its pulse. And yet, as we publish the latest Global Outlook, here we are: VIX has spent several weeks at very low levels, global equities are up in Q2, 10y Treasuries have traded in a tight range and struggled to break above the much-watched 3% level, and oil prices are up from last year. After a shaky Q1, risk assets have their mojo back, with EM the only major asset class to underperform.

This is impressive, given what investors have had to deal with. Bond yields exploded in Italy after months of political drama, Spain’s government fell suddenly, Germany’s ruling coalition looks shaky as we go to print, and Brexit negotiations seem to have hit yet another snag. The global economy slowed materially in Q1 – a slowdown that only became apparent in Q2 – and Europe and Japan are showing few signs of breaking out of this soft patch. As importantly, the US has upped the ante on trade. Steel and aluminum tariffs have been reimposed, the recent G7 meeting ended in public acrimony, and the US and China are engaged in a public staredown, with tit-for-tat tariffs that could run into the hundreds of billions of dollars. And yet risk assets keep bouncing back. What gives? Are markets simply in denial?

We don’t think so. Instead, we feel that investors are simply taking a ‘glass half full’ approach. And well they might. Step back from the noise and you find a global expansion that is still healthy (if more US dependent), well-behaved inflation, more clarity from the ECB and the Fed, and strong corporate earnings. Yes, there are risks, especially in relation to trade policy. But the underlying macro environment is a compelling counter to these concerns, which is why we expect risk assets to have yet another decent quarter (we are more cautious on EM).

The sharp-eyed amongst you will notice that we have changed the format of this edition of the Global Outlook. Henceforth, rather than running through each asset class one by one, we plan to focus on the most important themes that are driving markets. Financial markets are increasingly interconnected: our views on (for example) the outcome of US trade policy will shape our views on equities, fixed income, currencies, etc.

In this edition, we highlight two such themes: With US short rates now among the highest in the world, the global risk-free rate is also amongst the best yielding. This is an unusual state of affairs and influences our investment views. Separately, we look at scenarios in which 10y Treasury yields break out above 3%, and how any such sell-off could impact various asset classes.

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