Happy Black Monday

Somebody will call it “Black Monday.”

And I imagine the producers at CNBC availed themselves of the opportunity to roll out that dramatic-looking “market sell-off” vector graphic. The one with the zombie bear.

Ultimately, though, it was hard to get too bent out of shape, even as the Dow careened nearly 1,000 points lower into the US afternoon. After all, equities could afford to give some back. From the panic lows in March of 2020 to the record highs hit just days ago, stocks essentially doubled. The YoY gain was among the largest in history (figure below).

To say “we were due” (or just pick your favorite cliché) would be a laughable understatement. Coming into the week, the S&P traded at ~23x NTM earnings (LTM P/B was nearly 5, which scores 2.9 if you’re looking at z-scores).

Clearly, Delta variant concerns were in play, but I’ll continue to suggest that equities simply couldn’t look past the bond rally anymore. There’s a signaling effect from a dramatic drop in yields. The same goes for the grinding curve flattener. Eventually, stocks have to “recognize” what the bond market is purportedly “saying,” even as everyone knows the action in rates is largely position-driven and likely not indicative of much on the macro front.

Although the Russell 2000 didn’t egregiously underperform on Monday, reflation trades are fading (figure below).

“The shift towards more cyclical and value leadership that dominated the period from the 2020 March low to the beginning of this year reflected a particularly strong inflection point in growth and inflation expectations following unprecedented policy support and progress on vaccinations,” Goldman’s Peter Oppenheimer wrote Monday.

The bank’s basket of global cyclicals versus defensives tends to track the global composite PMI closely and if you believe the market is a leading indicator, the visual on the left (below, from Goldman), doesn’t bode particularly well. Specifically, Oppenheimer noted that “the recent fading of cyclical outperformance… would appear to be reflecting an expectation that the global PMI slows to the low 50s.” The same is true for global value versus growth (on the right, below).

More and more, it looks as though those who spent the last couple of months pounding the table on “peak everything” (e.g., growth, earnings, etc.) and the possibility that a falling rate of change could be enough to prompt a rethink for risk assets, were correct.

That reckoning was forestalled in part because there was no obvious catalyst to force the issue. The virus variant concern isn’t new, but as Goldman’s Oppenheimer went on to say Monday, the proliferation of the Delta strain conspired with “a slowing of US growth momentum and the peaking of all four China PMIs in June together with China’s relatively unexpected 50bps RRR cut last week [to] raise concerns about a loss of global growth momentum.”

Toss in the notion (however misguided) that the Fed is on the brink of a policy mistake, and risk appetite has finally rolled over. The figure (below) shows Goldman’s indicator flagging. If history is precedent, that could presage a further slowing in ISM manufacturing.

That’s where we were on Monday. While it’s possible (indeed, likely) that more friction between the West and Beijing (this time over “malicious” cyber activity) added to the bad vibes, the story is growth or, more precisely, worries about a lack thereof over the medium-term.

Looking ahead, Goldman cited client conversations. “Many believe the cyclical rotation was a short-lived phenomenon driven by a one-off recovery from an unusual recession,” the same note read.

That isn’t the base case on Wall Street, or at least not from what I can discern. And Oppenheimer said there’s “no strong consensus” among clients. But for those who think the cyclical rotation was short-lived, the rest of the narrative writes itself.

“Following the sugar rush of stimulus provided by a mix of monetary and fiscal support, we could well go back to a ‘secular stagnation’ environment of slow growth and low interest rates and inflation,” Oppenheimer wrote, sketching the contours of what one might call a “mean reversion” thesis for the developed world. “This argument is also supported by the fear that higher government debt levels will weigh on future growth should bond yields rise, providing a kind of automatic brake that constrains future growth and inflation,” Goldman added.

Happy “Black Monday.”