‘Surprise!’ Another 20/20 Moment

“We see scope for a setback in surprises in the late summer when diffusion indices naturally have to mean-revert lower again but it is just too early to expect it already now”, Nordea’s Andreas Steno Larsen writes, in a week-ahead outlook piece.

That echoes remarks from Deutsche Bank, who on Friday noted that positioning in equities has scope to rebound as the trend in the economic data is broadly positive (sans jobless claims, anyway) and investors look for “V”s in arguably dubious places.

Some of the hard data has, in fact, inflected in “V” fashion. Retail sales, for example, were a standout last week. But Nordea reminds you that “if everything was closed in April, then momentum can of course only improve in May, but to really hint a V-bound diffusion, indices would need to jump to much higher-than-usual levels”.

In any case, this isn’t really the kind of nuanced discussion investors want to hear right now, even if rationality demands open ears. The bottom line, as Steno Larsen writes, is that “if macro surprises are positive, equities perform”.

And really, we all should have seen this coming. This is another “hindsight is 20/20” moment for market participants.

It was obvious in March, when the world’s largest economies were shuttered, that any and all “playbooks” had to be tossed aside. The range of expectations for subsequent releases on key economic data points became comically wide, and PMIs were rendered almost totally meaningless. If you recall, India’s PMI nearly fell to zero at one point.

Given that, somebody, somewhere, probably should have suggested (loudly) that coming out of the lockdowns, various surprise indices were likely to inflect sharply. As difficult as it was to fathom the scope of the economic collapse in the wake of the lockdowns, there was at least something definitive about it — that is, we knew it was going to be really, really bad. Coming out of those lockdowns, there was no telling whether the rebound would be dramatic, decent, tepid, or non-existent, but the stage was set for upside “surprises” given that the downside was defined by “global depression” and we were already there.

“We noted last week that the unique nature of the pandemic shock and the wide uncertainty surrounding it has meant many surprises over the last three months”, Deutsche Bank said Friday. “Data improving significantly faster than consensus expectations in particular has seen our index of macro data surprises, the MAPI, surging to unprecedented levels”, the bank went on to write, adding that in the same vein, “the widely followed CESI index for US data surprises has risen to a record high”.

Again, considering the rampant uncertainty, this shouldn’t have been all that hard to see coming. After all, when uncertainty is the highest it’s arguably ever been, the scope for surprises is almost by definition unprecedented, and because we had already hit rock-bottom (almost literally) on some gauges of economic activity, the direction of those surprises was effectively a foregone conclusion.

But look, folks, this is all easy to say after the fact. In the moment, when equities were collapsing at the swiftest pace on record, and 1987 references were a daily occurrence, this kind of analysis seemed meaningless. All that mattered was getting ahold of USD cash and meeting margin calls. Just ask the following chart, which shows you the record plunge in the foreign US Treasury pile in March, indicative of a global fire sale to raise dollars.

Of course, this all has a self-feeding element to it. As Deutsche Bank went on to say Friday, “earnings forecasts for 2020 as well as 2021, have stopped falling and have been moving sideways for the last four weeks [as] revisions in consensus earnings forecasts are closely tied to macro data surprises”.

So, if these “surprises” continue, you could actually start to see upgrades.

Finally, Nordea’s Steno Larsen has a good take on why macro hedge funds retain a generally neutral stance vis-à-vis global equities “despite stories of massive risk on”.

“Maybe [it’s because] the current scenario is close to a nightmare for macro hedge funds since cross-asset correlation is super high”, he muses.

The following visual from JPMorgan illustrates the point.

“How do you yield an uncorrelated return if markets buy all asset classes at the same time?”, Steno Larsen wonders.

Good question.