Given the daily deluge of headlines documenting every twist and turn along what, rising soft landing odds aside, remains a treacherous road through a stagflationary economic environment, you might be tempted to suggest 2023 is all about the macro.
Day in and day out, we’re told that assessing the implications of the incoming data for the overall economic narrative, and thereby the read-through for monetary policy, is absolutely essential — that even second- and third-tier releases may be crucial for determining the direction of asset prices given the primacy of macro considerations.
As it turns out, 2023 is actually all about the micro, with an “i.” Or mostly about the micro anyway, assuming what we’re interested in is explaining individual equity performance.
The idea that macro factors have been “the principal driver of US equity market returns in 2023” is “a great misperception,” Goldman’s David Kostin said, in a new note. The bank’s analysis indicates that, very much contrary to the prevailing narrative implicit in media coverage, the index “has become increasingly micro-driven in recent months.”
In fact, nearly three quarters of the typical S&P 500 stock’s return can now be explained by micro factors, up some 30ppt over the past 12 months.
Return dispersion has moved up in tandem and is now approaching its long-term average, Kostin said.
As you’ve probably heard, correlations have collapsed of late. Dispersion rises when either single-stock vol is high or correlations are low. Vol has moved down steadily, which leaves the drop in correlations as the explanation for higher dispersion.
“Lower stock correlation outweighed receding volatility and drove return dispersion higher,” Kostin went on, adding that even as implied vol is low, the ratio of average single-stock implied volatility to index-level implied volatility now sits at a five-year high, suggesting dispersion should be elevated going forward.
At the same time, valuation dispersion — measured as the difference between the most expensive stocks and the least in multiple terms — remains extraordinarily high, ranking in the 84%ile looking back four decades, despite coming down from the stratospheric levels observed in 2021.
I should note that despite how I framed things here at the outset, this isn’t news to those steeped in markets on a day-to-day basis. As volatility drifted ever lower during this year’s summer equity melt-up, strategists often spoke (and still do) about the absence of “shocks” with the potential to trigger a “corr 1” trade. Typically, such events are macro shocks.
I suppose you could suggest the Fitch downgrade counted as a mini-shock, and indeed it did contribute to an “everything selloff” this week across bonds, stocks and credit, but the bear steepener it helped unleash has the potential to pick winners (or relative winners, anyway) within equities, which could theoretically contribute to more differentiated returns, not less.
It has been and is still my opinion that most of the inflation we have suffered and the equity returns we have seen are primarily the result of micro drivers, whether in supply chains, labor market activities, commodity markets, or selling price increases. When I bought my first McDonalds in Evanston, IL in Jan 1962, it consisted of a hamburger, fries and a coke for which I paid $0.37 total. When I bought my final McDonalds, a McDouble, fries and a drink from the value menu it cost just under $9. I won’t do that again. Interest rates had nothing to do with it, although for some customers the posted price of $10.25 for a Big Mac combo meal might require some financing. Years ago I understood viscerally that economists receive no useful training in the concept of profits. I majored in the subject and took six PhD courses, the core for doctoral students in the discipline. The bone readers theoretically understand stuff like marginal revenue and marginal cost, but nothing about the true nature of profits. We have fiscal policy (blamed for this latest bout of inflation by the mostly dim), monetary policy supposedly understood by the Fed (but not by the Congress who are currently mentored by MTG and Kari Lake), and no industrial policy at all because there are so many sort of tough questions requiring understanding no one seems to have. See, there’s our real problem, our “every human for themselves” system.