On Monday, we talked a bit about “simultaneous surges” in the context of a quarter (Q1) that saw risk assets explode higher on the back of dovish central banks and bond yields dive on growth concerns, with the bond rally accelerating following the March Fed meeting and subsequent position squeeze.
Now, the worry is that the “disconnect” between equities and bonds has created a scenario where the “jaws” will close via a sharp decline in stocks, as opposed to what we’ll just call a “benign/healthy” back up in long-end yields, reflecting the stabilization of global growth expectations. In that regard, Monday’s bond selloff was encouraging.
In the post linked above, we cited some brief excerpts from SocGen’s Andrew Lapthorne, who reminded everyone that quarters during which global equities and bonds rally concurrently are not in fact rare. We also talked at length about simultaneous rallies in stocks and bonds in the context of the negative return correlation between the two assets over the past two decades (i.e., when you have two assets that are negatively correlated, but which rally simultaneously over a longer time frame, you’ve got the best of both worlds – you can “have your cake and eat it too”).
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Well, with all of that as the context, we though it was worth briefly highlighting the following chart from Goldman, which shows that Q1 was the best start to a year for a traditional balanced portfolio since 1990.
(Goldman)
“The bounce back in growth expectations and a continuing dovish pivot from the Fed resulted in a Goldilocks backdrop – in expectations even if not in data realizations – leading to most assets rallying year-to-date”, Goldman notes, adding that while they were pretty sure the December rout and accompanying recession worries were overblown, “the speed of the recovery and the resulting moderation in volatility have been impressive.”
Yes, “impressive” indeed. As the bank goes on to write, “aside from a slight scare at the end of March, risky asset volatility drifted down throughout the quarter, recoupling with rates and FX vol, which remained largely anchored throughout.”
(Goldman)
As ever, the vexing quandary for investors is that the Fed’s dovish pivot (and the “follow-the-leader” dynamic it kicked off among the FOMC’s global counterparts) is ostensibly predicated on a deteriorating outlook. As BofAML’s Hans Mikkelsen wrote following the March meeting, “communicating dovishness is always tricky as there is a delicate balance between the benefit of stimulus and the underlying driver, which is economic weakness”.
The dovishness incentivizes risk-taking and to the extent the people taking the risks (i.e., chasing out the risk curve and down the quality ladder in search of yield) understand that central banks’ renewed commitment to accommodation is due to a less favorable macro backdrop, the willingness to reengage with carry trades comes down to an implicit assumption that policymakers i) will be successful in heading off a deeper downturn, ii) never believed such a downturn was likely in the first place, but rather were simply leaning dovish to protect risk assets or, more likely, iii) a little bit of both.
If those assumptions turn out to be wrong, then there’s going to be another adios muchachos moment for various and sundry short vol. expressions at some point.
I would not take a benign outcome to the bank. Don’t get me wrong, as an RIA I was grateful for the Q1 bounceback. But the fact is that most economic indicators are losing momentum (not claiming a recession just slower growth) and profit growth is challenged. Expanding P/Es and tight credit spreads are a slim reed to rest on versus the risk inherent in markets right now.