I suppose it’s occurred to most Americans by now that when it comes to reopening the country and lifting virus containment protocols, Donald Trump’s “Opening Up America Again” (and yes, that is the actual name of the guidelines) plan isn’t really much of a plan.
That’s not to say there’s anything “wrong” with the guidance the administration issued on Thursday evening. Rather, it’s simply to say that what Trump unveiled was essentially a Powerpoint presentation consisting almost entirely of common sense recommendations so rudimentary they needn’t have been codified. The first bullet point on slide five, for example, says “wash your hands with soap and water”. The “Appendix” is just one slide defining who counts as a “vulnerable individual” (hint: old people, sick people).
The bottom line is that governors are going to work out the specifics and logistics of this, just as they made clear to the president earlier this week, when two regional alliances were formed to coordinate reopening plans. That prompted Trump to accuse states of plotting “a good old fashioned mutiny”, a position he quickly abandoned, electing instead to give states discretion.
Trump’s characterization of mutinies as “exciting and invigorating every now and then” was a bit disconcerting, as it suggested he might turn the epidemic into a states’ rights fight during an election year, which I’m sure terrified some in the GOP.
“There is no ‘plan'”, Nomura’s Charlie McElligott wrote on Friday morning, of the reopening guidelines. “[There are] no deadlines, no protocols to businesses on protective gear, temperature checks, testing, or sanitizing, and little to no federal assistance, with states being asked to ‘independently’ secure PPE and medical equipment for their hospitals”.
Again, the “plan” is a Powerpoint presentation with recommendations, all of which are de facto voluntary and there’s little to no mention of how the federal government will assist or otherwise monitor the progress.
So, why did we see Russell 2000 futures looking to trade limit-up on Friday? Why the early/sudden bid for high beta, and cyclicals and the less liquid “stuff” that’s been so out of favor?
Before we get to that, consider the outperformance of big-cap tech to small-caps of late:
“Looking at the ratio of the NDX to the Russell 2000, it seems fairly indisputable that tech has entered bubble territory”, Bloomberg’s Cameron Crise wrote Thursday.
“Sure, the NDX has outperformed small-caps for years, and we all know that Amazon is well placed in the current context, but that doesn’t mean the advantage can never get fully priced”, Crise went on to remark, adding that “the pace of NDX outperformance over the last three months has ‘dotcom bubble’ written all over it”.
Nomura’s McElligott weighs in on this in his last missive of the week.
“The big talking point in US equities circles of the past week has been the extreme mega-cap outperformance over small-cap”, he says, noting that Nomura’s US equities “size” factor market-neutral strategy has suffered the biggest four-day rout in the past 10 years.
(Nomura)
What you see in that visual is a six-sigma event.
The explanation is simple. “Investors are in the liquidity and ‘safety’ of the mega-caps right now, on top of the obvious cyclicality and balance sheet dynamics of US small-cap equities as their negative feature, with those companies being the most negatively exposed to the downside of the coronavirus recession from a cash flow- / access to funding- perspective”, McElligott writes.
Earlier this week, after recapping the specifics of what turned out to be an extremely prescient near-term call on a momentum reversal “shock”, Charlie took a look at forward returns in historical instances of momentum shorts ripping in statistically anomalous fashion from multi-year lows (for those who missed it, there’s more on that here).
On Friday, he conducts a similar test for the kind of dramatic small-cap underperformance seen over the past week. When the size factor sees an anomalous cumulative four-day underperformance of this magnitude (in this case it was actually in the 0.1%ile going back to 1984, but McElligott uses < 0.2%ile for the parameter in order to get a larger sample), it historically entails bad returns in the near-term for equities, before stabilization out to three months, and then the potential for a large rally later.
As Charlie goes on to write, this “very much parallels” the message sent by the historical analog study on forward returns in historical instances of momentum shorts ripping.
Historically, it’s a setup for bad returns locally, before a modest stabilization and then, by 12 months, the median returns are large.
Summing up, McElligott writes that “the critical takeaway is… we now have yet another test which is signaling the potential for a US equities ‘regime change’ looking out in that six-month to 12-month window”.
Again, he notes that this “mirrors what the ‘momentum unwind’ analog showed us on Monday”. Namely, that recent relative price action viewed through the lens of similar historical episodes supports a potential value and cyclicals over growth and min. vol. trade looking out medium- to longer-term, which he reminds you “has historically been the case surrounding leadership trends into- and out of- a recession”.
Comparing megacap tech balance sheets vs small caps and cyclicals, the outperformance is understandable and they deserve a significant premium. The only major knock against megacap premium valuations is regulatory risk and the more they can do to help during these times (ie. Apple/Google partnership), the lower future regulatory risk will be. Any factor rotation into cyclicals/high beta will be temporary IMO.
https://www.theatlantic.com/technology/archive/2020/04/us-coronavirus-outbreak-out-control-test-positivity-rate/610132/ Not looking good that we are anywhere near ready to open up shop.
Great article.
Here in my area a small city was successful in getting tests and out tested the regional medical hub city by a wide margin.
Results: well tested rural small city positives .05%, regional medical hub city with three major hospitals and 18 times larger pop than the small rural city, positives .007%.
Initiative on the one hand providing better data, and self crediting for low numbers on the other hand where the local narrative and the local perception are in line with the weak data. Order of magnitude as mentioned in linked article is observed in this example.
This will drag on longer than most people believe.
The massive outperformance of megacap tech indicate, in my view, money being shoved into the market without real conviction in the economic fundamentals.
I struggle to understand why one would direct the bulk of one’s equity allocation into the FAANG or other megacap acronyms here. What is the realistic one-year return potential in already over-loved and over-owned stocks? If the economy recovers, maybe +20%? But if the economy indeed recovers, what is the return potential for all those beaten-down-and-left-for-dead stocks and sectors? I see doubles and triples all over the place, and you can be wrong on some (like, they go to zero) and still get almost a decade of gains in a year. If the economy doesn’t recover, which implies a very deep and lasting recession/depression, are the FAANGs going to outperform cash?
Logically, you buy FAANGs here because you feel like you must have exposure to equities but you don’t actually think there will be an economic recovery. That’s a very odd investment thesis, though it may make sense as a short term trade.