Hell Or High Water.

Over the past week or so, a palpable sense of frustration has set in among those steadfast in their belief that risk assets should not (and cannot) continue to ignore the rather daunting economic challenges presented by the coronavirus outbreak, which threatens to derail a global economy that was just beginning to recover after a year spent dodging bullets in the trenches of the trade war.

But, as stocks pressed to ever higher highs, frustration gave way to incredulity and, eventually, incredulity surrendered to a kind of fatalism. Blame passive flows, rate cuts, dovish forward guidance, the return of the central bank morphine liquidity drip or investors’ Pavlovian instincts (classically conditioned as they were over a decade of accommodative monetary policy), but equities are resilient.

In fact, US stocks pressed to fresh records on Wednesday, just one session removed from Apple’s revenue warning, ostensibly a harbinger of (bad) things to come for multinationals whose supply chains and product markets are exposed to the virus. Come hell or high pandemic, it’s record after record. Big-cap tech is gunning for a ninth weekly gain in 11.

European shares are at records too, and mainland equities in China have, of course, recouped most of the losses from the post-holiday plunge.

Still, there are plenty of signs that things are off-kilter or, if that’s not quite the right adjective, you might just describe the current environment as feeling “delicate” or “tenuous”.

Gold is surging despite a buoyant dollar, for example. In addition to the haven appeal, the precious metal is benefitting from plunging real rates in the US, and yet, those same negative real yields aren’t undermining the greenback, which is pushing relentlessly higher amid economic outperformance and expectations of monetary easing abroad.

Meanwhile, the yen (that “other” haven) plunged Wednesday as USDJPY surged on a combination of, in no particular order, short-covering, stop-outs, real money demand, hopes for Chinese fiscal stimulus, and recession worries on the heels of Japan’s worst quarterly GDP print since the 2014 tax hike.

But even as it is remarkable that stocks have demonstrated the kind of resilience they most assuredly have in the face of 2020’s two black swans (the Soleimani strike and the coronavirus), it’s not entirely inexplicable.

“CTAs are long equities (~85th percentile) as the equity trend signals stayed positive [while] volatility targeting and risk parity exposure is also elevated at ~75th percentile”, JPMorgan’s Marko Kolanovic wrote Wednesday, in a new note. He went on to explain that “the reason for this is a relatively muted response of multi asset volatility, with equity moves being offset by bonds”.

And then there’s the cushion from dealers’ gamma profile, something we mention nearly every, single day. “Option dealers were long S&P 500 convexity (gamma) most of the year, and this cushioned selling in the S&P 500 (‘buying the dip’)”, Kolanovic said, adding that “down moves were cushioned by stock buybacks that typically accelerate during market pullbacks”.

But how do we account for something that’s not humanly possible to quantify ahead of time? Or at least not with any specificity or precision? Namely, how do we quantify the economic impact of a virus which is still on the loose (so to speak)?

“With countless estimates of the impact on global growth being floated, we’re left to ponder just how much of a bounce to expect in real terms once nCov is contained”, BMO writes, before citing “an astute client” who rolled out another version of the “people aren’t going to buy two sandwiches to make up for the ones they didn’t buy while they were quarantined or furloughed” observation. To wit, from a Tuesday note from BMO:

If the coronavirus prevents consumers from going out to dinner for a month, once it’s resolved people aren’t going to have four weeks of double-dinners to make up for the lost consumption. This illustrates the nuance of the virus-driven shift in consumption patterns; after all, surgical mask sales are spiking.

For JPM’s Kolanovic, this can be expressed in terms of how quickly we get another “September moment”, if you will. In our coverage of Marko’s latest early Wednesday, we took a brief trip down memory lane as follows:

The market’s love affair with bonds went into hyperdrive last August amid a recession scare (exacerbated by convexity flows) tied to new tariffs. In early September, yields snapped back higher in dramatic fashion, causing multi-standard deviation unwinds across factors. “[These] US equities factor reversals will go down in infamy… as one of the more stunning trades in modern market history”, Nomura’s Charlie McElligott declared, on September 10.

That factor quake looked like the beginning of the end for the massive valuation disconnect between, on one hand, momentum/min. vol./defensives, and, on the other, value/cyclicals. In other words, it looked as though Kolanovic’s call from months previous was starting to play out.

“A key question is what will mark the inflection point when bond yields move higher and factors snap back [and] we think it will be containment of the epidemic and broader reopening of businesses in China”, Kolanovic went on to say, on the way to noting that “given extreme positioning, and various monetary and fiscal stimulative measures employed or in the pipeline, the snap-back could be more significant than last September’s event”.

If that turns out to be the case, it would be quite something to behold. After all, last September’s snap-back in yields and the factor rotations it catalyzed, were dramatic indeed.

For example, on September 9, the one-day return for Nomura’s value proxy (an EBITDA/EV factor) was in the 99.7th percentile going back to 1990. That same day, the one-day return for the bank’s one-year price momentum factor was a 0.0 (that’s “zero point zero”) percentile move. That translated into a truly insane 8.5-sigma event for the “Pain Trade”, documented here and visualized below:


When it comes to the virus, Kolanovic notes that if one looks “at the dynamic of new cases and recoveries, there is strong quantitative evidence that the epidemic is likely to start subsiding over the next few days”. He cites that evidence and also suggests investors should look to real-time economic activity in China, but notes that most market participants would rather just trust 10-year US yields.

“Most investors are not even trying to forecast various scenarios, but rather look to bond yields for an ‘all-clear’ signal for rotation and re-risking”, Marko writes. He also says discussions with clients indicate that 10s at 1.75% “would be a signal to sell momentum, sell tech (secular growth) and defensives, and rotate into cyclicals and value”. That’s around 17bps from where we are now, but it “feels” like more given the circumstances.

As BofA’s Michael Hartnett wrote late last week, there are “twin bubbles” in bonds and tech, and the bank’s fund manager survey for February showed a full capitulation into “slow-flation” themes. If 1.75% feels aspirational, 2% feels like Everest.


As expected, China slashed the loan prime rate on Wednesday, in keeping with the signaling from this month’s OMO and MLF cuts. The one-year tenor was cut by 10bps, and the five-year by 5bps. The one-year LPR is now 30bps lower than the old benchmark.

For all the details on China’s rate cut, you can read more here, but suffice to say Thursday’s move was a foregone conclusion, and marks the culmination of this month’s monetary easing measures.

For some folks out there, none of this nuance matters. For Joe E*Trader and Jane SPY, all that counts is where the US benchmarks close, and every evening, those folks see “new record high”, and are happy.

The irony is that they are contributing to the perpetual motion machine without even realizing it. After all, pouring more money into ETFs as stocks rise perpetuates what amounts to a price-insensitive (and certainly a valuation-insensitive) bid. “It is worth noting the high level of speculative retail activity, typically chasing the upside in popular high momentum tech stocks”, Kolanovic observed on Wednesday.

Come hell or high water. Record highs.


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