Markets stocks

What Pandemic? Not Much De-Risking Is Happening And One CIO Thinks It’s Nuts

"I have never in my career seen anything as crazy as what’s going on right now."

“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:

(Deutsche Bank)

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.


8 comments on “What Pandemic? Not Much De-Risking Is Happening And One CIO Thinks It’s Nuts

  1. The novel Corona Virus seems a Classic black swan (black bat?)…with asymmetrical characteristics.

    It is currently also a long on Chinese Party transparency, correctness of quickly applied identification techniques, and a short on western pandemic modeling.

    It could all be fine. AND even if it isn’t, the “markets” may still say that its all good.

  2. This market is being kept alive to facilitate the acquisition of huge amount of capital concentrated in the hands of the few… Not a lot of alternatives to the forward momentum exist because if any occur that can’t be throttled down by gamma hedges that Charlie and really H… (who has explained repeatedly for those of us who needed the repetition ) the mechanics of what is going on then likely a Recession of some magnitude will occur… The accumulating parties are well aware of the crowded theater analogy and probably will attempt not to participate..
    Do not expect a 48 hour notice when D (doom ) day arrives….just entertain yourselves with the comedy of ‘I told you so’s….

  3. I am mildly optimistic about China’s ability to get on top of the epidemic, given the extent of the govt’s control, willingness to suffer economic pain, and stimulus power to drive recovery.

    However, the number of cases outside of China are now at levels similar to China’s cases in mid January, and those numbers are, I think, seriously under-reported.

    I’m not saying that Singapore, say, is grossly underreporting. I’m thinking about other countries with travel links to China but much weaker medical surveillance and governments. Indonesia, for example. There have been zero cases reported in Indonesia – how believable is that?

    So I think it is likely that the virus will have a phase 2, which will be when it becomes visibly rampant in the emerging markets. Phase 3 will be when new cases accelerate in the US and other developed countries. There is, AFAIK, no medical restriction on traveling from Kuala Lumpur or Hanoi to the US . . .

    I’m not expecting a calamity, because I think effective treatments will be developed in due course. But I don’t think the nCov story is over.

    • Definitely the story is not over. This virus is here to stay, it will not disappear like SARS. Even if China will manage to contain it now (what seems to be really hard), it will periodically arise in different countries. Most likely travel industry will be affected for years, and consumption in general will suffer too, especially in South-East Asia.

  4. H-Man, putting the most optimistic spin on the virus and the world economy, still requires a double dose of omeprazole or whatever heart burn medication you prefer. No matter where you look, it looks bad and burns. While CB’s will provide more and more medication in the form of liquidity to offset the effects of the virus and the world wide blues, what happens when that medicine simply doesn’t make the burn go away? More succinctly, what happens when the liquidity elixir becomes snake oil?

    • When monetary policy alone is no longer effective the solution is likely to involve a hybrid monetary-fiscal policy answer. In other words, MMT.

      I believe that it has derisively been referred to as ‘helicopter money”.

  5. I was at a party 2 weeks ago. I was listening to someone bragging about being long FAANGs, TSLA, etc. they just recently purchased an 8 figure home. I listened looking for a way out. Someone came up and mentioned I am a HF guy and that this guest could “pick my brain”. I cringed but stayed silent as he asked me what a Hedge Fund is. For a guy worth as much as I suspect and with wealth mgmt guys probably calling him constantly I was surprised. I told him I am long some of the names he mentioned (like we all are) but that I am short some of those names and others. After explaining what a short and hedge is he asked me why in the world would someone do that when they always go up. Well, he may have a point as he sure has outperformed my fund. But it also tells me the complacency out there. And he has no clue about the competitive threats, bal sheet issues, valuations etc.

    This is more common that we think. We tend to overestimate our abilities (I do as well). I saw this in 99/00 and have seen it now building from 17 to today.

    I have weathered a few of these over the decades but honestly I have never seen a time where pretty much everything is rich (driven off rates).

    I have the luxury to preserve and build the weath of the investors and individuals/retail do as well. Take advantage of that asset as I suspect that optionality is very undervalued currently.

  6. reminds me of the client who fired me in 7/2019 because I was running 15% UST in his portfolio which was therefore only beating the SP50 YTD by 150 bp. We talked about valuations and risks and he said “of course it’s going to blow up, but it’s going up now!”

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