On Tuesday, we highlighted some short excerpts from a recent note penned by BofAML’s US high yield credit team who gently reminded folks that “strong rallies should lead to less, not more optimism.”
The time to be skeptical about the scope for additional losses was on December 24, when stocks careened lower in a horrific Christmas Eve “massacre” that marked a kind of “sum of all fears” moment for markets following Powell’s tone deaf December press conference (on December 19), Trump’s decision to shutter the government and Steve Mnuchin’s ill-advised decision to try out his Hank Paulson impression.
Sure, hindsight is always 20/20, but it was readily apparent that the pessimism had run well out ahead of economic reality and that market participants had fallen victim to a dour narrative of their own construction.
Of course narratives can become self-fulfilling and if sentiment remains sour, that can start to manifest itself in real economic outcomes which are then cited by the same people who crafted them as supporting “evidence” in a self-referential insanity loop magnified by the liquidity-volatility-flows nexus described by JPMorgan’s Marko Kolanovic last month.
In any case, the question now is whether the ferocity of the “snapback” bid for risk in January has effectively capped the upside going forward. That’s another way of saying what we spelled out over the weekend, in “Back To The Drawing Board.” It may well be too late for anyone who didn’t participate in January, especially if it turns out that the Fed has “squeezed the max amount of blood from the stone” when it comes to how much can be accomplished in terms of reinvigorating risk assets with a dovish capitulation.
A simple look at the juxtaposition between returns for the S&P and junk bonds in December and January tells you pretty much all you need to know.
That’s the context for a Goldman note dated Monday evening which essentially finds the bank arguing that if you missed January, you might well have missed the entire year.
“At the outset of the year, benchmarking returns against macro data suggested that equities were already pricing a very sharp slowdown in growth and profits”, the bank writes, on the way to reminding you that at the time, they “argued that a modest bounce at some point early in the year was likely, and if investors missed it there would be a risk of missing the bulk of the returns for the year.”
That bounce took the form of a ~15% SPX rally and a near 10% rally on the Stoxx 600, and while we’re of course not back to the September highs, Goldman notes that “neither is the economic data.”
So, what does this mean going forward? Well, for Goldman, it means it’s time to reiterate the “flat and skinny” story.
“We see no reason to return to the December lows but, while we saw a bounce in equity markets in 2019, we also argued that this would be followed by the resumption of a ‘flat & skinny’ trading range, with relatively low equity returns”, the bank says, adding that while “there is still a ‘slight’ dislocation between market returns and the economic performance, the over-shoot on the downside which was so evident at the outset of the year is no longer as large.”
In other words: curb your enthusiasm and brace for a range-bound “grind” – if you will.
Goldman also notes that “more idiosyncratic, micro markets” aren’t generally conducive to “sharp factor or sector swings” as those tend to be driven by “large moves in economic outcomes or big shifts in BYs – neither of which we forecast.”
That’s a debatable position. Clearly, a decisive shift to late-cycle trades would usher in dramatic factor rotations and sector swings, so this really all hinges on whether the recession story is more imagined than real.
Finally, it’s worth noting (and we bring this up all the time) that in the absence of a downside catalyst that forces stocks lower and pushes volatility up, systematic flows could well drive equities steadily higher – especially considering still-low exposure for the Long/Short universe (first chart below) and the vol.-targeting crowd (bottom chart).