Is this “as good as it gets”?
That’s a question that haunts risk chasers across the globe in the new year on the heels of a truly remarkable rally across assets of all stripes and one of the most dramatic collapses in cross-asset volatility in recent memory (last week’s flare up in rates vol. notwithstanding).
At its core, this is a question of whether monetary policymakers are still capable of reflating given the ostensible capacity constraints inherent in still-low policy rates and still-engorged balance sheets. 2019 is also somewhat unique in that key investor groups who haven’t participated in the YTD rally are left to ponder whether the cause of the central bank policy pivot (and, relatedly, the signal from DM bond markets) is more important than the pivot itself when it comes to where risk assets go from here. If the global economy careens into a downturn (as bonds seemed to be “saying” until this week), then some of the trades folks piled into on the back of dovish policy pivots aren’t going to perform very well.
That’s the narrative, and it serves as the backdrop for the latest global strategy paper from Goldman’s Christian Mueller-Glissmann and co.
There’s a lot to parse in the note, but we wanted to zoom in briefly on the section that suggests “the easy money has been made.”
The bank starts with an update on their GS Risk Appetite Indicator, which we’ve highlighted in these pages from time to time. As you might imagine, the indicator has bounced off the extreme levels seen late last year and now sits closer to neutral.
As Goldman writes, extreme low levels on the RAI are rarely followed by negative 12-month returns for US equities, and vice versa. “In the recent mini-cycle our RAI has provided particularly good signals – in January 2018, close to peak in the S&P 500, it reached the highest level since the 90s while in December 2018 it dropped close to -2 (excluding safe havens)”, the bank writes. Here’s a fun scatter:
As far as the current rebound in risk appetite is concerned, Goldman says the recovery off the December 24 lows (i.e., the still-running bounce off the Christmas Eve massacre), “is tracking the average recovery since 1990 relatively closely.” The visual on that looks like this:
As you can see from the blue-shaded area there, history suggests a pretty wide range of possible outcomes going forward. If you’re wondering whether that means “the fundamentals” will likely take over from here, Goldman thinks the answer is yes. To wit, from the note:
However, after 3 months there tend to be larger differences in recoveries as macro fundamentals take over as a driver relative to sentiment and positioning – this indicates in the next 3-6 months the uncertainty on the path for risk appetite increases. In other words, ‘the easy money’ has been made with the risk appetite overshooting to the downside in December and recovering again – the RAI is nearly back to levels from early Q4 2018.
If you’ve been following along over the past several months, you’ve probably already got your rejoinder ready, which should go something like this: “But even though sentiment has recovered, isn’t positioning still light? And if so, doesn’t that mean the ‘pain trade’ could still be higher as folks get dragged in by the persistence of the bounce and still-suppressed vol.?”
Yes and yes – or at least from where Goldman is sitting. First, the bank illustrates the recovery in sentiment (both survey-based and in the options market) as follows:
Next, they write that while futures positioning has “picked up” (thanks, one assumes, to both the systematic crowd and macro funds adjusting as the rally runs), “participation from investors more broadly has been relatively limited, resulting in one of the largest gaps between equity performance and equity fund flows since the GFC.”
That’s a reiteration of the whole “flow-less” rally story that’s been making the rounds for the last two months and which, generally speaking, forms the basis for a lot of bullish calls.
“Normally flows tend to be closely linked to performance and risk appetite”, Goldman adds, contrasting 2019 which what’s “normal” during periods when risk is “foaming at the mouth” (to employ one of Charlie McElligott’s favorite vivid descriptors).
Read more on the “flow-less” rally
What accounted for the lack of participation in Q1? Well, probably some combination of folks being shell-shocked from the Q4 tumult, jitters about what ended up being the longest government shutdown in US history, lingering doubts about a trade truce and, of course, ongoing signs of global economic malaise.
And on that note, we’ll just leave you with one more short excerpt from Goldman’s note which finds the bank suggesting that while the “pain trade” may still be “up”, things are “fragile”:
In our view the lack of investor participation has been due to the very fast recovery in risky assets coupled with the initial lack of positive growth momentum. It also suggests the ‘pain trade’ might still be up, which can support risk appetite further. But without a sustained pick-up in global PMIs in the coming months, we believe risk appetite is unlikely to turn positive and remains vulnerable to shocks, similar to 2015, and might be driven by speculation on political risks in Europe, a US-China trade deal or secular stagnation fears