At this juncture, it’s probably just a matter of what “breaks” first in the “everything rally”.
With the FOMO siren song beckoning to sidelined Homeric heroes, there’s an argument to be made that reengagement by hedge funds and other under-exposed investor cohorts could drive equities higher still, especially given scope for further re-risking by some systematic strategies assuming volatility remains suppressed.
You might have read a somewhat misleading headline last week about hedge funds having their “worst start to a year” since 2012. Without getting into the specifics, the original source for that was this Bloomberg article. It’s true Q1 marked a bad relative start to the year for hedge funds, but even there, there’s more than a little nuance to be had. Here’s the real story, verbatim from HFRI:
Hedge funds had their best quarter since 2006 in Q1. Hedge funds advanced in March, led by Macro and CTA strategies, concluding the strongest first quarter for industry performance since 2006, according to data released by HFR, the established global leader in the indexation, analysis and research of the global hedge fund industry. The HFRI Fund Weighted Composite Index gained +1.0 percent for the month, bringing the 1Q19 performance to +5.9 percent. Risk Parity strategies surged in 1Q19 with the HFR Risk Parity Vol 15 Index advancing +14.9 percent, the strongest quarter since index inception.
Nuance aside, equity hedge funds have underperformed the broad market. While that’s not exactly something that’s new, it is news (with an “s” at the end) considering how far stocks have run in the new year. Here’s monthly performance for the HFRX Equity Hedge index:
Obviously, that 5.95% YTD gain pales in comparison to the S&P and as we’ve mentioned repeatedly, part and parcel of the bull thesis from here is the assumption that those who are underinvested will ultimately get yanked back in (kicking and screaming in some cases, considering the still tenuous macro backdrop).
The linked Bloomberg article above cites Marko Kolanovic, so I suppose it’s worth excerpting the following passage from his March 21 note again (more here):
The volatility targeting community (including insurance products, platforms, dealers’ products, and other asset managers) is likely in the ~25th percentile of their equity exposure range and HFR global HF index beta is below its 10th percentile. Our prime brokerage business reports net equity exposure in its ~36th percentile.
Before this turns into a tangent, allow me to steer us off the rumble strips and back onto the highway. “Hedge funds” is not a catch-all term, so you should beware of headlines and blog posts devoid of nuance, but that said, generalized underexposure and underperformance from equity strategies is pervasive and in an environment where benchmarks continue to sprint towards new record highs, “force-ins” (as it were) could serve as an accelerant on the upside.
So, if you’re still feeling bullish even after the S&P has run more than 15% YTD, well then you’re probably basing that on some combination of optimism about an inflection in the global economy and the rally being too much to resist for anyone who’s still on the sidelines (especially if they have investors to answer to).
That said, if you’re in the camp that thinks cyclical concerns are not in fact overblown and that the worst is still to come for the global economy, well then you’re probably pointing at every major global benchmark and shouting “too far, too fast.”
The first week of Q2 was a blockbuster for equities both stateside, and especially abroad. The DAX, for instance, jumped more than 4% last week (see top pane below), while the Hang Seng tacked on 3% in Hong Kong. Mainland Chinese shares added nearly 5% to a Q1 rally that saw the CSI 300 surge an incredible 29% (bottom pane below). And on and on (and on).
Minutes to midnight
All of this as DM bonds can still be heard shouting “downturn”, despite last week offering a bit of respite from the recession story thanks to, in order, upbeat Chinese PMIs, a better-than-expected ISM print stateside and Friday’s “Goldilocks” jobs report in the US that saw hiring snap back in the neighborhood of “trend” after February’s grievous miss.
This week’s marquee data point is CPI and if it comes in soft on the heels of Friday’s cooler-than-expected AHE read for March, well then all the better for the “patient” Fed. But really, it would take something truly dramatic in terms of an upside inflation surprise to change the narrative – the burden is indeed on the data to put hikes back on the table, but that burden is heavy.
We’ll also get the March Fed minutes this week, which will obviously be parsed for more information on why no hikes are expected this year and also for additional color on the balance sheet plan. Here’s BofAML:
We will look for answers on what factors led the majority of FOMC participants to rule out another rate hike in 2019. Many officials will likely point to the weaker trajectory of growth and inflation in their outlooks and argue that a shallower path of policy will allow them to sustain the current expansion and help them better achieve their goals. They will likely again highlight that the downside risks from slowing global growth and geopolitical factors (e.g. Brexit, USChina trade negotiations) allows the Committee to be patient and gives them an opportunity to pause and assess the state of the economy. That said, we will be curious to see if there were any discussions on what conditions would be necessary for the Committee to restart the rate hikes. Also, conversely, we will look for any hints on what conditions would warrant cuts in the policy rate. We suspect that significant deterioration in economic activity, major market volatility and/or further slowing in inflation could prompt the Committee to consider providing further accommodation. Comments since the March FOMC meeting suggests that the bar is relatively high for cuts but how the Committee weighs these risks could give further insight into their thinking.
Since the March meeting (and also despite Powell’s best efforts to get dovish enough to placate the White House), Donald Trump has tripled and quadrupled down on his Fed criticism, with Friday’s calls for rate cuts and a resumption of QE being just the latest example.
“Data in the US have supported risk sentiment, with an improvement in PMIs, auto sales, and strong job creation easing concerns about an impending slowdown, while stable wage growth is keeping inflation risks contained”, Barclays wrote Sunday, adding that “the market narrative of cautious optimism has been benefitted from reported progress (although no details) in the US-China trade talks and the higher likelihood of a softer Brexit.”
It’s at least possible that the Fed minutes end up being a slight negative to the extent they serve as a stark reminder that there’s a fundamental reason behind the dovish pivot. Barclays underscores this, writing that “this week’s FOMC March meeting minutes will likely remind markets why the Fed shifted so sharply to the dovish camp [and] we expect them to highlight downside risks to the economic outlook.”
Also on deck in the US are PPI, factory orders, University of Michigan sentiment and the monthly budget statement, which should be funny.
Out of ammo?
The ECB will take center stage across the pond and while there will obviously be no actual change to policy, this will nevertheless be an interesting affair coming as it does on the heels of a March meeting which saw the GC unveil deep cuts to the outlook, enhance the forward guidance on rates and, critically, announce a new round of TLTROs which the market is keen on hearing more about.
Folks will also want to know where the tiering discussion stands amid rampant speculation.
Relive the March meeting
“Several ECB speakers have pointed to June potentially being the key month in which we might learn about the details of the new TLTROs [and] we would expect the same from Draghi” who may also “reinforce Praet’s message last week: TLTRO conditions will be tailored to the data flow, suggesting there is still room for a ‘generous’ round close to what we saw in the last batch”, BofAML says, in their preview, before adding the following color on the tiering debate:
Draghi is likely to be asked about tiering, whether it could open the door for further cuts if needed, and whether it could come in isolation. Our expectation is that Draghi can easily replicate what Praet said last week, implying that the conversation about the side effects of central bank measures on banks made sense if rates were to stay low (not lower) for longer. We still think the bar is set very high for rate cuts.
Needless to say, the outlook for the euro-area continues to darken, although there were some ostensible bright spots last week. Germany is teetering precariously on the edge of recession and thinks look to be on the verge of unravelling again in Italy (where a recession came calling in Q4 and likely extended into Q1). Here are a couple of handy snapshots:
“Euro area growth is forecasted to deteriorate, and upside surprises in sentiment are yet to prove a bottom out of weakness in hard data”, Barclays lamented over the weekend, adding that “this week, we expect a further contraction in euro area IP.” Although the bank says “Brexit risks appear underpriced in EUR”, they caution that “some Europe-specific risk factors lurking in the background, including possible US tariffs on EU autos, EU election risk, BTPs, are also yet to be priced in.”
Right. Of course you wouldn’t know that to look at Italian equities or at the Stoxx 600 Autos & Parts index, because both are now in bull markets.
Oil is likely to start getting interesting as renewed fighting in Libya raises the specter of disruptions at a time when prices have already surged dramatically.
On Sunday evening, Khalifa Haftar (who is marching on Tripoli) moved to impose an actual no-fly zone in the west. The National Army (a somewhat euphemistic moniker) said in a Twitter post that “any military jet will be considered a target as well as its takeoff location.”
This comes amid the ongoing tumult in Venezuela and oil market watchers will likely also be interested in the details behind a rumored US decision to designate the IRGC as a terrorist organization. Qassem Soleimani‘s Quds Force has long been maligned for its role in supporting Hezbollah and other Shia militias in the region, but designating the IRGC would amount to Washington calling another country’s military a terrorist group. Obviously, that isn’t going to go over particularly well in Tehran and it would endanger US forces in the region and likely lead to further instability in Iraq.
Crude is already perched at a five-month high and Donald Trump still doesn’t seem to fully grasp the notion that his strategy of bullying and badgering the Saudis into effectively offsetting any upward pressure on crude emanating from the administration’s “tough on Iran” stance has its limits. At a certain point, it’s no longer about the actual numbers, but rather about the extent to which Trump is raising the odds of conflict, with unpredictable consequences. Additionally, it’s no longer clear that OPEC is inclined to acquiesce to Trump’s every Twitter whim.
Meanwhile, China’s FX reserves rose for a fifth straight month (on valuation effects from the bond rally) and look set to remain stable going forward. At the same time, Beijing is buying a lot of gold recently. The PBoC’s holdings of carefully-polished yellow doorstops rose for a fourth consecutive month in March to 60.62 million ounces from 60.26 million in February.