“In a rising market, equity investors typically find themselves shorter equities than desired, but once a correction arises, investors quickly find themselves much longer equities than desired”, JPMorgan’s Nikolaos Panigirtzoglou writes, in the latest edition of the bank’s popular Flows & Liquidity series.
I know what you’re thinking. You read that quote and immediately perceived something quite tautological about it. That is, of course folks wish they were longer when stocks are rising. And, on the flip side, obviously everyone wishes they weren’t as long when stocks are falling.
But Panigirtzoglou is actually referring to a lengthy, nuanced discussion about how equities have reacted to economic news in 2020. It’s an interesting bit on its own, but for our purposes here, I wanted to zoom in on two simple visuals from the note:
In the simplest possible terms, those visuals suggest the market may be vulnerable. Both CTA trend and discretionary funds would appear to be very long equities. In fact, they’re nearly as long US stocks as they were in January of 2018 during the post-tax-cut melt-up.
“For momentum traders such as CTAs, we use our momentum signal framework [which] shows that the average z-score of the short and long lookback period momentum signals for the S&P 500 and Nasdaq indices has risen to its highest level since January 2018”, Panigirtzoglou writes.
Meanwhile, Equity Long/Short hedge funds’ beta rose dramatically in November and December (think: “playing catch-up”) and remains elevated. Here’s Panigirtzoglou:
Looking for example at monthly reporting Equity Long/Short hedge funds, their beta to the MSCI AC World index stood at 0.53 in October 2019, i.e. just above the historical average of 0.5, but rose sharply to 0.66 in November, 0.76 in December and 0.77 in January, pointing to a significant overweight position. The January beta of 0.77 is not far from their peak equity beta of 0.81 previously seen in December 2017.
You can draw your own conclusions, but when it comes to the Long/Short crowd, Panigirtzoglou simply writes that “the still elevated sensitivity of hedge funds to global equities suggests that little de-risking happened in response to coronavirus, and hedge fund exposure to equities remains high”.
You can hardly blame managers for being reluctant to lean against the wind (or, more aptly, against the liquidity tide). After all, hugging benchmarks would have made you a standout performer in 2019.
Although Deutsche Bank’s indicators vary depending on which investor cohort you care to zoom in on, the following two visuals give you a consolidated look or, more colloquially, they provide a kind of 30,000-foot perspective:
The above is by no means an exhaustive study of current positioning, but it’s probably fair to say that risk assets have not priced in any kind of worst-case scenario from the coronavirus, something Guggenheim’s Scott Minerd was keen to emphasize in a somewhat bombastic note published late last week.
I’ll leave you with a quick passage from his entertaining missive entitled “Peace For Our Time“:
For those investors who perceive the disconnect between risk assets which are priced for a rosy outcome and the reality of the looming risks to growth and earnings, any attempt to reduce risk leads to underperformance. It is a mind-numbing exercise for investors who see the cognitive dissonance. The frantic race to accumulate securities has cast price discovery to the side. In the world of corporate bonds and asset-backed securities, issuers are launching deals and then tightening spreads to Treasurys by 25 basis points or more relative to where the last similar new issue was priced just a day before. They are also upsizing deals, as it has become common to see new issue bond underwritings ten times oversubscribed. The giant flood of liquidity is driven by virtually every central bank in the world injecting reserves into the system. And many investors today don’t even buy individual bonds, they purchase a basket of bonds that can be traded versus an exchange-traded fund (ETF). The quality of the bond doesn’t matter; no one is actually negotiating a rate or a price. In the ETF market, prices are set by pricing services that frequently use stale data when no price discovery has occurred. The result is a non-market price determining where a security is trading and there is no additional price discovery, meaning nobody is negotiating individual bond prices. If it is in the index, buy it! This is what price discovery has become. This will eventually end badly. I have never in my career seen anything as crazy as what’s going on right now.