Blame mom and pop.
That, roughly speaking, is what some folks have resorted to in the course of explaining why equities can’t seem to sustain a rally.
Headed into December, more than a few strategists thought the stage was set for a year-end squeeze higher. Needless to say, those hopes have been dashed in dramatic fashion.
On Tuesday, Nomura’s Charlie McElligott delivered a sweeping assessment of the factors that have conspired to reinforce the “sell the rips” mentality that, while observable at various intervals in 2018, has now entrenched itself as the dominant psychological driver of the price action.
So entrenched is that mentality, that John Williams’ well-articulated walk back of Fed hawkishness only managed to boost stocks for roughly 18 minutes on Friday before the bottom fell out anew amid government shutdown jitters.
Among the factors McElligott cited on Tuesday: the recent retail exodus from equity funds, which he characterized as “tectonic”.
“Retail now really stepping it up -$15.5 bil this week (sub 1st %tile) and now 6m outflows hitting -$59bil (8th %tile) and over the year -$102.4bil”, he wrote, adding that “this is coming with Nov and Dec as historically the 1st and 2nd best months for monthly US equities flows on average since 2005.”
It is, Charlie said, “a total puke [that’s] ‘anti-seasonal’ which nobody expected.”
This comes at a particularly inopportune time, with the buyside calendar-constrained and in any case stinging from recent chop and the October purge, while every sustained move lower takes us further and further from re-risking levels for the momentum chasers. All of that in an environment of lackluster liquidity and against a domestic political backdrop that is laughably fraught.
Well, in a new note, Barclays Ajay Rajadhyaksha underscores retail investors’ role in the rout. He too is skeptical of the notion that the U.S. economy is on the verge of a recession and says the December drawdown “is not due primarily to a rise in market perceptions of tail risks or to a sharp dialing down of baseline growth expectations.” Rather, the current drawdown “shows signs of being the infamous ‘retail flush’,” Rajadhyaksha reckons.
“Retail investors [are] suddenly pulling a large amount of money out of equities [and] a qualitatively different nature of the sell-off this month is that it has been quite uniform across equity sectors and styles”, he goes on to write, before noting that this “is in contrast to the initial leg in October, which was mainly a sector rotation out of cyclical stocks.”
In other words, this has become indiscriminate, which suggests asset class-level outflows as opposed to discretionary selling based on perceived vulnerabilities at the sector level.
Frankly, if you look at a simple Bloomberg study of sector-by-sector performance from September through last week versus performance from December 3, the only thing that really sticks out is Utilities, so it might be a bit of a stretch to suggest that somehow things are more “indiscriminate” now than they were in October/November. But what isn’t disputable is that retail is bailing. “Fund flows during October were not material and despite the volatility, retail investors did not blink but held steady”, Barclays contends, on the way to delivering the following assessment with regard to what’s changed:
However, the situation changed dramatically last week after the S&P 500 broke out of its trading range. Last week had outflows of nearly $40bn, mainly from mutual funds, rather than from ETFs. Retail sentiment as proxied by the AAII survey has also turned quite bearish.
So what’s got retail so spooked? Well, according to Barclays, it’s either the fact that retail investors “have been used to positive annual returns in their portfolios for the past several years [and] as equities finally moved into significantly negative territory this year, some of them decided to move out” or else it’s that “retail is more susceptible than the institutional community to the steady media drumbeat of rising recession risks.”
Have a look at the following Google Trends chart which reinforces that latter point:
When it comes to the recession meme, Barclays is in the camp who thinks this is largely a fata morgana.
“It is true that the collective markets sometimes do a better job forecasting a turn in the economy than forecasters and policymakers [and] this was largely true in 2008 as well, so perhaps this is one of those times”, the bank muses, before immediately expressing skepticism for the following reasons (and these are truncated):
- Equity markets often given false signals.
- Doomsayers will immediately turn to the bond markets for corroborating evidence. It is true that starting in Q4, the bond market started pricing in an ease in 2020. But just 11-12bp of easing is priced for that whole year, less than a 50% probability of one 25bp ease. If the markets were seriously worried about a recession, we would expect several eases to be priced in.
- There are virtually no indications – especially not in critical indicators such as the labor market or consumer spending, both of which typically slow down a few quarters before recession – that raise worries about US economic growth.
That is generally inline with what most sellside strategists believe with regard to the recession narrative. That is, Wall Street thinks it has little to no merit – or at least not right now.
Finally, Barclays cites low liquidity as another contributing factor to the recent equity turmoil. We’ve been over this ad nauseam, including on Saturday in a lengthy exposition.
“Poor liquidity has likely exacerbated price gyrations”, Barclays says, flatly, pointing to the following chart which (again) shows market depth is severely diminished.
Ultimately, the bank is staying with their year-end 2019 S&P target of 3,000. Not to be derisive (this just is what it is), but the bank in August actually tweaked their model to produce a higher year-end SPX target for 2018 just as stocks made new highs.
As a reminder, had Barclays stuck to their old model, they would have needed to cut their 2018 S&P target to 2,825 in August, but after the model tweaks, they raised that target from 2,900 to 3,000.
Finally, as a kind of appendix, we wanted to update you on a trio of popular charts we’re often asked about. Below find, in order, proxies for the U.S. equity exposure of the Long/Short crowd, CTAs and vol.-control funds.