Diamond Hands

Risk sentiment was reasonably buoyant Wednesday, as global equities rose lacking any obvious catalyst other than a slight abatement of the bond selloff.

As usual, the financial pages fit the narrative to the price action, and they enlisted strategists in the effort. “A lot is going quite well for the economy,” someone told Bloomberg. If equities were down, you’d get the glass half-empty take.

In any case, it feels like the capitulatory purge some folks were waiting on to signal the all-clear isn’t coming. I’d submit that’s not necessarily a good thing. It’s easier to justify playing offense once there’s evidence to suggest something like despondency and fatalism has set in among the “herd,” as it were. Instead, some investor cohorts appear to have adopted the “diamond hands” strategy popular in Reddit memes and crypto circles.

“Last week, clients were big net buyers of US equities for the second week,” BofA’s Jill Carey Hall noted. In fact, the $5.2 billion weekly flow was the ninth biggest in the bank’s post-GFC data series.

“Clients bought equities across all size segments,” Carey Hall went on to say, adding that “retail clients led the buying but institutional clients and hedge funds were also buyers for the second week and first time in four weeks, respectively.”

Commenting on that data, and specifically buying in individual stocks, Bloomberg’s Joe Weisenthal (who now has a Heisenberg Report subscription courtesy of some generous individual who gifted him access for Christmas), called the flows “indicative of the urge to gamble.”

Could be. Although I’ve been compelled to rethink my own assumptions about what counts as “gambling” vis-à-vis markets lately. When heavyweights like Facebook and PayPal notch declines large enough to destabilize indexes and upend ETFs that hold them, it makes it more difficult to castigate the crypto crowd (or anyone still enamored with meme stocks). Have a look at the figure on the left (below).

Facebook’s post-earnings losses are approaching $300 billion. The figure is ~$480 billion from the highs in September. That’s around 40% of the total value lost in the cryptosphere during the most recent drawdown (figure on the right, above).

That’s not an argument for allocating more to crypto than to Comms Services. It’s just to say that it’s all gambling at the end of the day. And with S&P 500 concentration risk at record highs (figure below), the stakes are getting higher in US equities.

Clearly, Facebook is an anomaly, but it does underscore the notion that US stocks are just one giant long duration bet. When something calls into question analysts’ growth assumptions, the bottom falls out. Thankfully, the rest of the “generals” are carrying Meta’s weight.

“Meta continues to be a source of funds and make new lows,” JonesTrading’s Mike O’Rourke remarked on Tuesday evening. “[It’s] essentially returned to its pre-pandemic levels,” he added.

Meanwhile, bonds obviously haven’t been your hedge. “A 60/40 portfolio lost 6.7% from its intra-month peak to trough, the worst January drawdown since 2009,” BofA observed. The simple figure (below) illustrates the point.

This was always the risk. Far from being a shock absorber and a buffer against mercurial equities, your risk-free asset is the proximate cause of the angst in risky assets. As I suggested earlier this week, this isn’t a proper “tantrum” yet, but it’s possible bonds become a source of portfolio volatility going forward in the event Fed hikes aren’t digested well despite money markets’ best efforts to telegraph what’s coming. Note that JGBs are testing the BoJ, with Japanese 10s pushing up near 0.25%.

The good news is, “[rate] hikes almost never mean negative annual returns for equities and credit,” according to BofA’s Jared Woodward. In fact, he said, total returns on the S&P “have averaged 16% (8.1% annualized) during hiking cycles back to 1954 compared to 12% average annual returns in all years.”

Of course, that comes with quite a few caveats. It all depends on the macro environment, and the Fed is hiking into an extremely stretched market. And then there’s the standard cliché: Past performance may not be indicative of future results. Especially when the pain threshold beyond which stocks react violently to rate rise seems to get lower by the year.