Remember 2018?
Maybe you don’t. After all, in the temporal dimension we’ve all occupied since January 20, 2017, one year feels like roughly 457, so 2018 was a long, long time ago. And quite a bit has happened since then, besides.
But I’m old enough to remember Q4 of 2018, when financial conditions tightened the most of any quarter since the financial crisis.
(Goldman)
That was down to a combination of factors, including wider credit spreads and falling stocks, themselves occasioned by two factors: 1) US monetary policy that was widely perceived as having pushed the envelope too far, perhaps in an effort to “prove” something to the White House amid an increasingly aggressive campaign to encroach on Fed independence, and 2) political uncertainty both with regard to US trade policy and domestic issues tied to the government shutdown.
Disentangling all of that is quite difficult, if not wholly impossible. But one critical thing to note is that irrespective of how it all conspired to catalyze the harrowing rout in Q4, risk assets eventually lost patience with rising real yields, which remained stubbornly elevated following Jerome Powell’s “long way from neutral” misstep (in early October), even if breakevens eventually plummeted towards the end of the year.
Rising real yields stateside contributed mightily to the appeal of USD “cash” which, you’ll recall, outperformed nearly 90% of global assets in 2018.
Flip the calendar and things couldn’t be any more different. Here is an updated version of a chart that got a lot of attention late last year:
(BofA)
In 2018, less than 20% of more than 300 assets across stocks, commodities, currencies and credit, posted an annual gain. In 2019, that figure is 92%. Here’s BofA’s Barnaby Martin:
2019 can be summed up in one word…breathtaking. Breathtaking returns that is. Consider that this year should see annualized US high-grade total returns of +15%, US high-yield returns of +14%, 10+yr Italian government debt returning +25%, Greek long-end govies returning +53% (and outperforming Greek stocks) and even US T-bills posting 2.5%. In fact, this year is drawing to a close with 92% of all assets across the globe having produced positive total returns, a breadth of asset price appreciation on par with ‘09 — a time when the global economy was emerging from the Lehman episode.
Martin is the bank’s European credit strategist, so the note from which that excerpt is taken is written from that perspective, but the overarching point is that 2019 has been the opposite of 2018 for one very simple reason, namely “the enviable combination of good valuations… turbo-charged down the line by central banks furiously easing policy to the tune of a mammoth amount of interest rate cuts across the globe”.
(BofA)
Of course, that means pervasive financial repression. Indeed, the following chart shows that yield scarcity is getting more acute, the recent bond selloff notwithstanding (note the red line in the visual – that spike reflects the plunge in long-end yields that played out in August).
(BofA)
As noted here on Wednesday, the likely persistence of an accommodative lean from policymakers makes it possible to argue for buoyant risk asset prices on at least a couple of fronts:
- If, on one hand, growth remains sluggish and inflation fails to respond convincingly, the “everything rally” can persist, as bonds are bid on “slow-flation” dynamics, while “TINA” and the promise of abundant liquidity bolsters equities and credit.
- If, on the other hand, stimulus does start to manifest itself in better economic outcomes (e.g., an inflection for the better in manufacturing PMIs), you can argue that although bonds may suffer in a pro-cyclical rotation, equities will rise on risk-on sentiment tied to improving macro, and credit can rally as the cycle is prolonged.
This kind of “heads bulls win, tails bears lose” reasoning makes it tempting to stay bullish equities (and credit) as long as there’s not a clear-cut case for aggressive policy tightening or signs of an imminent turn in the US cycle.
For his part, BofA’s Martin expects 2020 “will be the year where the bulls still pull it off, and credit spreads — by and large —head tighter, albeit with the bulk of tightening front-loaded”.
You may be able to say something similar about equities. That is, front-loaded gains with volatility starting to manifest itself later due to political turmoil into the US election (e.g., on a Warren win in the Democratic primary) and the realization that no matter what happens with “Phase One”, there will never be any comprehensive trade deal between the world’s two largest economies.
Read more: S&P 5,300, Bear Market ‘Signposts’ And The Persistence Of The ‘Exceptional’
