FOMO is back en vogue, both as a favorite click-generating acronym for market-focused web portals and as a real-life dynamic gripping investors who remained parked on the sidelines for Q1s remarkable rally, which saw (almost) everything post positive returns.
Between the epic/epochal/shocking/[fill in your favorite superlative] dovish pivot from global central banks and the growth scare that prompted that pivot, both risk assets and DM government bonds have surged, leading directly the following state of affairs:
Its an everything rally and unsurprisingly, thats been accompanied by a rapid collapse in cross-asset volatility (last weeks spike in rates vol. notwithstanding). You can read more on the scope of that collapse (the most dramatic by some measures since Draghis whatever it takes moment) here, but the bottom pane in the visual below is a simple representation from the perspective of global equities and, notably, crude, where Q4s dramatics have given way to a calm supported by a rebound in prices.
The top pane there is just the S&P (with weekly returns) which continues to push higher, buoyed by an apparent return to a Goldilocks macro backdrop in the US and incessant banter about an imminent Sino-US trade truce.
All the while, key investor groups have remained on the sidelines, a situation thats led analysts to dub Q1 a flow-less rally characterized by a big fat buyers strike, under-positioning and under-exposure.
As we’ve noted countless times over the past several weeks, one of the key pillars of a bullish thesis on risk assets from here is the notion that those who have watched the 2019 surge from the sidelines will ultimately succumb to their “worst” impulses and dive in, driving equities higher. That, despite common sense dictating that after such a rapid run-up, returns are likely to be more muted from here, barring a confluence of bullish fundamental catalysts (e.g., a convincing inflection in global growth, signs that China is set to embark on a “kitchen sink” stimulus push, a definitive end to trade frictions, etc.).
If you ask SocGen, this isn’t the time to chase. “As equity markets drift higher and higher, the temptation to chase risk assets higher is growing on many investors”, the bank writes, in a note dated Thursday, before warning that in their view, market participants should “fight the fear of missing out.”
The bank starts by acknowledging the scope and ferocity of the move higher. To wit:
- Risk assets have indeed been on a roll since the turn of the year, having by-and-large reversed the sell-off of late 2018. Brent crude oil prices increased by 29%, equity markets had their best quarter since 2009, volatility compressed further with the VIX trading near 13.5 and emerging markets attracted over $100bn of non-resident flows in the first three months of the year, according to the Institute of International Finance. Both investment grade and high yield credit spreads tightened back below 140bp and 500bp respectively as risk-off sentiment receded at the start of the year. In fact, long diversified investors would have struggled to lose money in the first three months of the year, with all asset classes moving higher year-to-date.
See there? You would have “struggled to lose money” even if you were trying.
Amusingly, the bank cites the same lack of participation that bulls cite as a likely catalyst for more gains as evidence of rampant consternation which should serve as a flashing yellow light for anyone inclined to dive in.
“Year-to-date returns on equity markets may be impressive, but market flows (or lack thereof) show that conviction is shallow”, the bank cautions, adding that even as event risks recede, “cyclical headwinds persist.” They also reaffirm their long-standing call that the cycle is at (or near) its end and that the US economy will ultimately “fall into recession in the coming quarters.”
SocGen proceeds to remind you that rates have “by-and-large already priced in a turn of the cycle.” While they concede that long-end yields stateside might have overshot a bit (on the downside), the bank nevertheless assigns a 35% probability to 10-year yields remaining below their Q4 target of 2.50% given the prospect of ongoing cyclical concerns creating a persistent bid for bonds.
As far as credit goes, SocGen is less than sanguine. Here are a couple of quick excerpts:
- Weaker economic growth will also mean a cyclical turn of credit. The significant increase in the level of debt and balance sheet leverage, both in the US and in emerging economies means credit spreads are vulnerable to a repricing. While our credit strategists expect USD IG credit spreads to widen to 175bp by year end (compared with 146bp currently) with fair conviction (60%), they also see an additional 15% probability that credit spreads could widen above and beyond their target levels.
Duly noted, but as ever, this is a tug-of-war between the dovish pivot from central banks and the impetus for that same pivot. That is, dovishness is ostensibly good for risk assets and the fact that the policy turn combined with growth jitters has driven DM bond yields into the floor (and below in Germany and Japan) means voracious appetite for anything that offers some semblance of yield. That’s a positive technical for credit. But if growth outcomes surprise materially to the downside (i.e., everyone’s worst fears are realized), excessive leverage and a definitive turn in the cycle could be bad news.
After running through some commentary on FX, China and EM more generally, SocGen underscores the “tug-of-war” dynamic as follows:
- In short our analysis shows the balance of risks is still broadly titled to the downside for risk assets and we recommend investors gear their portfolio allocations for the tug-of-war between bad cyclical indicators and more policy loosening.
In short, then, SocGen appears to believe it might be best if you make like Odysseus and have yourself bound to the mast so as not to be tempted by the sirens.
Here, for those interested, is the full breakdown of the bank’s key calls, complete with conviction levels and upside/downside risks:
Final note: the above is but a brief summary — the full note contains some 30 pages worth of analysis that sheds further light on the situation and the rationale for what you see in the table.