Markets are forward looking and the near universal adoption of the The Great One’s famous skate-ahead-of-the-puck mentality by people who wouldn’t know a tired cliché if it body checked them, means every nascent macro narrative is subject to relentless front-running.
As a result, macro themes have a tendency to become consensus trades long before they’re borne out, and very often before they have a chance to manifest in the data.
Currently, the consensus narrative still revolves around the notion that the first half of 2023 will be characterized by an economic slowdown across the developed world and a likely earnings recession in the US, ultimately prompting the Fed to pause rate hikes and then pivot to (mild) easing in the back half of the year, setting the stage for a recovery in risk assets.
The problem with that (assuming there is one) is the implied “cleanliness,” if you will. There’s elegance in simplicity, but this particular macro narrative is perhaps a bit too “tidy,” to use the adjective employed on Wednesday by Nomura’s Charlie McElligott.
Earlier this week, Morgan Stanley’s Mike Wilson suggested that consensus could be “right directionally, but wrong in terms of magnitude.” Specifically, Wilson believes markets may be underestimating the downside for equities in the event of an earnings recession, an economic downturn or both.
And yet, it’s also possible that global growth and profits continue to surprise to the upside, forcing a rethink of various Fed pivot trades (in rates) even as ongoing evidence of disinflation helps make the case for a Fed pause.
Those two outcomes needn’t be contradictory. Indeed, that conjuncture (better-than-feared growth against ongoing disinflation) is the definition of a soft landing.
Already, macro funds, emboldened by a year spent profitability riding trends, appear to be on offense. “Funds are moving much faster to grab into ‘risk-on‘ expressions and/or unwind legacy ‘risk-off‘ positioning in order to not start the year in a hole,” McElligott said, noting that performance betas versus a month ago suggest re-risking.
Macro funds’ beta to equities and crude is up markedly, and a short-dollar preference is evident in higher betas to the euro, lower dollar-yen betas and a higher beta to gold. Charlie attributed that to an “ahead-of-schedule disinflationary regime change hit[ting] simultaneously in conjunction with a better-than-feared global growth trajectory.”
But, again, it’s important to note that better growth outcomes and risk-on behavior across markets together imperil a variety of pivot trades in rates, from simple bond longs to aggressive bets at the front-end, where the recessionary bull steepener would arrive on any recession shock and subsequent Fed relent.
“With the outlook for global growth looking better by the day versus pessimistic consensus expectations for the first half, it is beginning to look like the risk remains ‘higher rates for longer’ than the recent bullish bond trade has priced,” Charlie went on to write Wednesday, adding that there’s now a risk that the earnings recession can gets kicked for what would be the third consecutive quarter. “The fixed-income market’s desire to get bulled-up on ‘pivot’ trades seems a bit too preemptive [as] leveraged funds and macros… keep getting their hands blown off by the current surprise growth resiliency across major economies, as well as increasingly punitive negative carry/roll in holding these positions.”
And yet, to toss in another wrinkle, CTAs’ long-standing G10 bond short is at least partially intact thanks mostly to the strength of the signal from the one-year lookback. So, notwithstanding better growth outcomes and the potential for another “clear-the-lowered-bar” dynamic during Q4 earnings season in the US, additional evidence of inflation moderation has the potential to trigger a squeeze in bonds. As McElligott put it, “the big flow risk remains a massive forced ‘buy-to-cover’ on, say, a dovish light CPI print.”
As for the implications of adverse inflation data (e.g., evidence that price pressures are becoming more entrenched on the services side or outright upside surprises on the main aggregates), the risk is obviously an unwind of recent short-dollar, risk-on trades.
McElligott used this week’s forthcoming CPI report as a hypothetical. A hot print could cause the dollar to “scream on renewed Fed hiking trajectory bets,” while longs in bonds and equities would obviously be at risk from a sudden FCI impulse tightening on a stronger dollar and higher real rates.
I’d note that irrespective of what December’s CPI report shows, the various push-pull dynamics discussed above will be relevant and in play for the foreseeable future.
Heisenberg seems to be saying there’s a lot of FOMO (fear of missing out) going around.
I don’t think central bankers around the world pay much attention to “the market’s” opinions. You see those opinions all the time, people saying what they think the central bankers should do.
Those opinions don’t matter, what matters is what central bankers actually do. And they have been fairly explicit in saying what they’re going to do, so there you have it.
Moreover, I’d favor what “wealth management” folks are saying. Reason being – They have to be right. If they don’t preserve a client’s wealth, they’ll be fired. A strong incentive, so to speak. Just sayin’
Central banks absolutely pay attention to the market’s opinion. Not so much in 2022 given inflation realities, but even there, you saw a constant dialogue between Timiraos, the Committee and STIRs (and not necessarily in that order) with everyone trying to get on the same page. During the post-GFC era, the market’s opinion was almost all that mattered to central banks, particularly beginning with the September 2015 FOMC meeting, when Yellen postponed liftoff amid the fallout from the yuan deval the prior month. Also, STIRs (and markets in general) can (and do) corner policymakers by leaning so far in one direction that failing to bend the proverbial knee risks adverse consequences. As far as wealth managers, some of those stodgy folks can hang around for decades while habitually underperforming. Mom and pop aren’t going to fire Bob Johnson, wealth manager, because Bob underperformed SPX by 200bps in an up year. A big hedge fund, by contrast, might have to close the doors if something goes too terribly wrong.
Also, Bob Johnson, random wealth manager, is irrelevant to the Fed. Hedge funds, on the other hand, aren’t irrelevant. Depending on the circumstances, their positions may need to be bailed out, particularly if Treasurys are involved. Just ask March of 2020. Nobody cares what wealth managers think, unless you’re talking about SWFs or something like that.
All I know is these wealth management guys are all leaning towards the S@P 500 bottoming out somewhere around 3200-3400 this year. If that doesn’t happen maybe stodgy old Bob will get fired and come looking for you.
Dana –
Thanks for your hopeful thoughts. I’d like to know what the bottom will be. And your note inspires some thoughts. In trying to imagine what’s ahead, I still have this aura of uncertainty and ambiguity hanging over me, but it’s difficult for me to actually be pessimistic about stocks.
What encourages me is a hard fact: In March 2020, I saw the S&P 500 index quoted a just a touch over 2300. It wasn’t long ago. It was the beginning of the pandemic, which is mutated, but still present.
I’ve placed my bets going into this 2023. Like you, I don’t foresee the SPX going anywhere near the pandemic lows. I’m betting on promising companies that are as low as (I think) they’re going to go. I’ve sold some loses.
Everything up to now – selling the losses and making the picks – has been easy. Now comes the uncertainty and the waiting for these (hopefully) choice, small-cap growth stocks to grow and flower. I want to see the war over in Europe. I want to see a world of stability and calm. But that’s not going to happen on my schedule, unfortunately. That just the way of the world right now, and I can’t do anything about it.
I hear quite often the quote “the stock market is not the economy”. But with central banks paying attention to the market’s opinion, might the stock market have more to do with the economy than the quote implies? It certainly has seemed that way for the past 14 years anyway.
My name is not Bob and I am not stodgy! But nobody cares about my opinion, except my clients and a small number of followers and that is how it should be.
for me this just confirms that we’re in “no person’s land” right now, and will remain so for the foreseeable future…if our central bankers admittedly don’t know what’s going on (“One way to say it would be that I think we now understand better how little we understand about inflation,” ) why should the rest of us…? …there are myriad possibilities what may unfold over the next few to several months imho …
“The fixed-income market’s desire to get bulled-up on ‘pivot’ trades seems a bit too preemptive [as] leveraged funds and macros… keep getting their hands blown off by the current surprise growth resiliency across major economies, as well as increasingly punitive negative carry/roll in holding these positions.”
This quote threw me a little. How are fixed income markets trying to get “bulled-up” on any pivot trade? Does he mean fixed-income investors are waiting on a peak terminal rate before wading back in?
When rates go down, bonds go up, so bond traders are going long now–getting “bulled-up”–in anticipation that the pivot to rate cutting is coming soon.
This is what I would like to know-
What is the $4.3T of cash, that is currently sitting on the sidelines, going to do in 2023?
You can’t time the market… but don’t fight the fed. Pretty much all I know.