US equities are in the process of “moving on,” and in this context, that’s not necessarily a good thing.
The zeitgeist has shifted. So far in April, sector performance betrays a defensive rotation, as “recession” looks poised to become the base case.
Equities are “now operating under an assumption of US economic contraction,” Nomura’s Charlie McElligott said, flagging “thematic signs of a preemptive re-allocation.” The simple figure (below) makes the point.
“Defensive positioning has been the right move,” Morgan Stanley’s Mike Wilson remarked. “Typically, defensives act poorly in a rising rate environment as they serve as a bond proxy in many ways [but] bond proxies are doing well,” he added.
Similarly, McElligott noted that out of 13 Nomura factor pairs, just four are in the green in April: Low Risk, Size, Quality, Momentum and Dividend. That “screams contraction,” Charlie cautioned, juxtaposing outperformance with high beta expressions, which are “getting hit hard.”
The economy has been in the “Slowdown” phase of Nomura’s quadrant framework for quite some time. Looking ahead, the odds are tilted towards remaining there or transitioning into the “Contraction” phase, amid tighter financial conditions (see the probabilities on the left, below).
Writing Friday, McElligott noted that historically, the thematic trade once the phase shift into “Contraction” occurs “looks a lot like what’s been happening” in April. The table on the right (above) illustrates the point.
In other words: Equities are already trading a US recession. Maybe markets are efficient after all.
Read more: US Recession Is ‘Soooo Consensus’
These hyper-fast cycle changes have been amazing over the past 2 years. Even skating to where the puck will be (…versus where it is now) leaves you behind and (largely) out of the play.
I swear, QUAL never goes out of style