“As you know, people have actually sold equities and put them into bonds this year”, Stanley Druckenmiller reminded viewers, during an interview with Bloomberg TV this week.
His point was that despite massive returns for stocks, not everyone has been on board. Part of the problem is that rampant policy uncertainty (exemplified in the on-again/off-again trade war) has kept market participants on edge, even as stocks climbed the proverbial “wall of worry”.
Of course, putting money into bonds hasn’t exactly been a bad trade either. Thanks to central bank rate cuts and the economic conditions (e.g., lackluster growth and falling inflation expectations) that necessitated them, bonds have had a stellar year too. The “everything rally” is in full effect, although obviously, bonds have slipped a bit over the last four months as yields bounced off the August panic lows.
The chart below illustrates the extent to which central banks have largely succeeded in insulating market-based measures of volatility from measures of “politicians’ implied vol.”, if you will. A chart that plots rates vol. (as opposed to the VIX) against the same Economic Policy Uncertainty index tells a similar story.
Will 2020 be different? That is, will investors be shy about plowing money into stocks again despite the blockbuster returns logged in 2019 and the fact that, looking back over the past three decades, the S&P tends to do extremely well following years during which the benchmark posts big gains?
If you ask JPMorgan, a flow shift is imminent. “We look for 2020 to be the year of Great Rotation II, in a repeat of 2013 the year of Great Rotation I”, the bank writes, projecting an epic pivot.
The bank notes that their call faces at least one “major challenge”: Retail investor equity positions would have to move above the highs seen during previous equity cycle peaks. But such a “structural change” is justified for a number of reasons, not the least of which is “the current global yield picture”, JPMorgan says.
The bank goes on to state the obvious, which is that yields on cash and bonds have come down, thanks in part to rate cuts.
“If cyclical or policy risks recede into 2020, it would be difficult for asset allocators to not accept higher equity weightings, perhaps even higher than those seen at the peaks of previous equity cycles”, JPMorgan says.
Obviously, this would have dramatic ramifications for the equity demand outlook next year. Here’s the bottom line, from Nikolaos Panigirtzoglou, Marko Kolanovic and John Normand:
In particular, for 2020 we see an overall improvement in equity demand of around $200bn relative to this year. This projected improvement is driven by retail investors and Equity Long/Short hedge funds. It is offset by a projected deterioration in equity demand by CTAs and Balanced Mutual funds. At the same time we expect that global equity supply will be lower by around $200bn relative to this year, as equity offerings slow and buybacks pick up. Adding up all the projected equity demand changes between 2020 and 2019 and subtracting the supply change, we come up with an Equity Demand/Supply improvement of $410bn in 2020 relative to 2019. This is around half of the equivalent Equity Demand/Supply improvement seen this year relative to 2018, which is estimated at $850bn (Figure 10). In other words, 2020 should be another good year for equities but likely half as strong as 2019.
We would note that this is, as ever, subject to a few caveats regarding policy uncertainty. Nobody seriously believes the trade war is over, and while we’re admittedly a sucker for a progressive policy agenda, we’re under no delusions about what would likely befall stocks in the event the market gets the idea that a Democratic sweep and a rollback of the 2017 cuts is in the cards.
Who knows, maybe things will be quiet in 2020 compared to the deafening cacophony of the manic news cycle investors have been subjected to over the past several years.
Somehow, we doubt it, though.
If we had to guess, we’d be inclined to think Druckenmiller’s assessment of 2019 will apply in the new year as well. That is, traders will be left “wondering about where the hell the next bomb is coming from”, constraining their ability to take the positions they’ve taken historically.