US equities’ best string of weekly gains in two years has the punditry resorting to nebulous proclamations, amorphous aphorisms and pseudo-tautologies again.
This happens whenever calm settles in. It’s the flip-side of the overwrought, hair-on-fire rhetoric that accompanies selloffs and bouts of volatility.
Whenever daily swings compress and the vol. sellers reengage, “tranquility reigns”; things are “eerily quiet”; the calm is “incredible”. Just like when price discovery occasionally reasserts itself and markets become two-way beasts again, there’s “chaos”, “anarchy” and “blood in the street”.
To be sure, it’s been a nice run. The S&P has risen for six consecutive weeks, the longest streak since the halcyon days of 2017. As Bloomberg notes in a lengthy tribute to “unheard of peace” (and yes, that’s a quote), the S&P will mark 29 sessions without back-to-back daily losses on Monday. Average peak-to-trough moves have collapsed, along with realized vol. and correlations.
The linked piece is chock-full of fun quotables like this one from Matthew Miskin, of John Hancock Advisors:
You do want to have a good bulk of your portfolio in equities. You haven’t seen any euphoria yet. That’s still to come. You’ve got to participate in that.
And then there’s this one, from Paul Brigandi, managing director at Direxion, pioneer of triple-leveraged ETFs that shouldn’t exist:
You’d think nothing’s happened. It’s incredible.
With all due respect to Paul (who, odds are, is a nice guy, although I can’t say for sure), it’s not “incredible”.
The most recent grind higher began in mid-October when a variety of “worst-case scenario” expressions collided with twin positive macro catalysts in the announcement of the “Phase One” trade deal and what counted as “progress” on Brexit. Since then, the market has moved from hoping that the interim Sino-US trade agreement will be accompanied by the postponement of the planned December 15 tariff escalation, to being something close to sure of it. That’s become somewhat self-fulfilling. Now, the market has baked in tariff rollbacks, China has insisted on them, and unless Donald Trump wants to risk wrong-footing everybody and catalyzing another “Nightmare Before Christmas” (if you like), the White House will have to validate those expectations.
Meanwhile, a string of somewhat upbeat (although “upbeat” is a relative term in this context) economic data stateside conspired with the trade optimism to set the duration trade on fire, leading to a massive WoW purge and the biggest weekly outflow from TLT in history.
Money fled bonds and cash, and before you knew it, “FOMO” was the acronym du jour again. At the same time, the pro-cyclical rotation that looked like a head fake in September, suddenly became “real”.
“Although the equity market has started to price an acceleration in US economic growth, we believe the recent rotation has room to run”, Goldman wrote Friday evening.
“Based on their historical relationships with our CAI, the broad S&P 500 rally and the rotation to Cyclicals from Defensives both appear to imply an acceleration in the CAI from the current 1.2% to a pace of roughly 2%”, the bank went on to say, adding that their own forecast for US real GDP growth shows an acceleration “beyond 2%, reaching a pace of 2.3% in early 2020”.
All of that despite the manufacturing sector still being mired in contraction for a third consecutive month. Here’s a fun visual:
You may rightfully call that a heinous “chart crime”, but it is what it is: US stocks are overbought for the first time since the spring, and ISM manufacturing is loitering near a decade nadir.
Sentiment has also been bolstered by better-than-expected earnings. Although profit growth did flatline as expected in the third quarter, the YoY contraction wasn’t as deep as feared.
“Equity funds received strong inflows for the third week in succession, and exceeded bond inflows by about $10bn over the three week period”, Deutsche Bank wrote Friday, noting that “this snaps this year’s trend of equity flows lagging bond flows by about $40bn over any 3-week period on average”.
Panning out to a 30,000-foot view (i.e., stepping away from the dynamics that have dominated over the last month), the reason equities have climbed steadily higher in 2019 despite the persistence of the trade war, all manner of geopolitical turmoil and, now, a spiraling impeachment probe which poses an existential threat to a business-friendly president whose tax cuts were singlehandedly responsible for adding around $13 to S&P 500 EPS in 2018, is the same reason markets were able to weather the populist wave in 2016 and 2017.
The disconnect between market-based measures of volatility and measures of policy uncertainty is down to monetary easing and forward guidance. That is, the calm is the predictable result of central banks going back into accommodation mode.
The pace of easing is far outstripping even the trend in disinflation (left pane below), and “peak” quantitative tightening is now a distant memory.
Given that, it is not “incredible” that volatility is subdued and that stocks are now grinding ever higher. During Q4 of 2018, the Fed was still expected to persist in rate hikes and balance sheet rundown and the ECB was calling an end to net asset purchases, even as the macro backdrop across the bloc was clearly deteriorating.
Fast forward a year and things couldn’t be any more different on the monetary policy front. The proverbial “state of exception” does appear to have become at least semi-permanent.
Coming full circle, the observation that stocks are hitting new record highs “again” is largely meaningless. US stocks rise over time. It’s what they do, and it’s why anybody who professes to be telling you something novel by extolling the virtues of investing in corporate America can be summarily dismissed as either a charlatan seeking to extract management fees for doing nothing more than buying an index fund on your behalf, or else a simpleton who doesn’t realize that he or she is just quoting Jack Bogle.
And that’s the end of that.