“With the S&P 500 and MSCI World showing their 4th best start of the year since 1929 and 1970 respectively, investors are now wondering if the so-called ‘sell in May and go away’ effect can erase the gains displayed so far”, Goldman wrote on Monday evening, invoking a cringe-worthy, old market adage in the course of essentially asking the same question that everyone has been asking about 2019’s remarkable surge in risk assets – namely, “How sustainable is it?”
At this point, analysts and commentators have presented, debated and otherwise expounded on pretty much every plausible explanation for the V-shaped recovery off the “Christmas Eve massacre” lows. Going forward, those of a bullish persuasion contend that under-exposure and the “flow-less” nature of the bounce leave room for further upside as fundamental/discretionary investors are pulled in and systematic strategies continue to re-leverage.
As for the dramatic collapse in volatility that’s accompanied the surge, JPMorgan’s Marko Kolanovic reminded folks on Monday that declining stock correlations have been critical when it comes to driving realized vol. lower.
“Since January, market volatility declined by 80% (e.g. 1 month realized volatility of S&P 500 dropped from ~30% to the current level of ~6%) and stock correlations also dropped by ~80% (1M realized correlation fell from 71% to 13%), contributing to nearly half of the volatility decline”, Marko wrote, adding that “the decline in stock correlations causes the index to ‘tread water’ even as growth-value, cyclicals-defensives, low volatility – high beta stocks pairs have rather large moves.”
(JPMorgan)
If you’re wondering whether that’s in part attributable to hair-trigger style rotations and, relatedly, lightning-fast factor swings, the answer is yes. Kolanovic also notes high gross exposure but low net exposure.
Additionally – and this is something we’ve been over dozens of times – Marko writes that “the past three months, the market was record long convexity, [which] suppresses intraday market moves by creating intraday reversion patterns.”
More simply, it appears as though there’s always “someone” buying the proverbial dip – an invisible hand, as it were. And when you throw in the corporate bid (buybacks) which further helps to tamp down turmoil, realized vol. gets “crushed”, as Kolanovic puts it.
If you ask JPMorgan, US equities can trade higher from here as key investor cohorts who were left behind in Q1 reengage. The bottom line is that being overtly bearish is getting harder – at least for the bank’s clients. “When talking to clients, we don’t find many truly convinced bears at this point, but rather investors who would like to add at ~5-10% lower levels and capture a return to new all-time highs”, Marko wrote. The implication is that if there is a pullback that’s not predicated on some kind of earthquake (geopolitical or otherwise), the dip will probably be bought.
For their part, Goldman thinks it’s at least worth mentioning seasonality when you think about the path forward.
“Historically, we find risky assets tend to perform well in the first part of the year (from January to April) while they tend to suffer in Q2 and Q3 (from May to August)”, the bank wrote Monday, in the same note cited here at the outset. “As a result, the distribution of equity returns tend to be much more positively skewed during the first part of the year.”
(Goldman)
So, sell?
Not exactly. After noting that seasonality tends to be strong in EM and following a brief discussion of HY (spreads have always tightened in Q1 post-2009 before widening back out from May through November), Goldman writes that in their view, “seasonality alone is unlikely to be a reason for lower returns.”
In fact, when the bank looked for evidence (i.e., correlation) between strong performance during the first four months of the year and performance from May through August, they came up largely empty.
With all of that said, there’s a common sense argument to be made that blistering returns aren’t likely to be entirely sustainable, unless 2019 should turn into some kind of historic bonanza. So, while you’d be fully justified in maintaining a constructive outlook, you’d also be forgiven for thinking that returns will be more muted from here.
