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Editor's Note: Hamish Risk | November 17, 2020
The market regime change triggered by news of a potential coronavirus vaccine is once again at the top of the agenda and in today’s briefing Pennock Idea Hub explains why the news should usher in a stampede into a cyclical and reflation trade that will last for months, while RenMac quells investors’ fears over rising Treasury yields. MI2 Partners warn the great rotation may not be smooth, however, highlighting the risks to equities from the imminent deleveraging across markets. At the heart of all of this rotation, is of course quant investing As Libra Investment Services explains, to varying degrees, all investors are “quants” now and data is king. But the price action of momentum this past week or so has been instructive, and has cast a shadow over quant-factor investing strategies. As Libra see it, factor model investing has failed as a strategy, not just in the last week, but over the past decade. Indeed as quant models have moved on and Libra go as far to say that we may soon be witnessing the ”revenge of the stock pickers.”
equity rotation Pennock Idea Hub
1. Everything you need to know about the “Great Rotation” but were afraid to askIn this piece, published just prior to yesterday’s Moderna vaccine news, Cam Hui from the Pennock Idea Hub explores the market signals, and looks for confirmation, of the beginning of a major equity rotation. Last week’s vaccine news was the spark for a Great Rotation, he argues. Hui has been monitoring the cyclical and reflation thesis for several weeks, some of his reports we have featured in our briefings, and had been waiting for confirmation that the global economy is on the rebound. His main criteria was a break the leadership of the Big Three factors, namely the U.S. over global stocks, growth over value and large caps over small caps. He says we now have definitive signs of breaks in all three factors. When the character of the macro environment changes so does the leadership, and this is only the initial phase of the Great Rotation, says Hui, which should usher a stampede into a cyclical and reflation trade that will last for many months. In terms of positioning for the move, Hui says commodity indices have recovered above their 50- and 200-day moving averages (dma). More importantly, the cyclically sensitive copper/gold ratio is also turning up. In the U.S., cyclical sectors and industries are also tracing constructive patterns in their relative performance. All are turning up, says Hui’s analysis. Semiconductors, which are both cyclically sensitive and considered to be growth-cyclicals, are on fire, he notes. Even Leisure and Entertainment, which supply consumer services that have been devastated by the lockdown, are ticking up. European equities aren’t absent from the party either, exhibiting a pattern similar to the U.S. market, though Financials are the laggards.
bond yields Equities Renaissance Macro Research
2. Rising yields won’t hurt stocks – yetDespite the muted response of bond yields yesterday to the vaccine news, Jeff de Graaf at RenMac maintains that yields are bottoming and should continue their march higher. However, he doesn’t believe rising yields will negatively impact equities, a commonly aired worry in the financial press. For starters, he says, real yields are still negative and the short-end is anchored with little risk of the Federal Reserve raising rates any time soon, especially with inflation cooling. Secondly, de Graaf says looking at the correlation between stocks and yields, he finds yields only begin to negatively impact stocks at 3.62% – at least 175 bps away from where the market stands today. Indeed, de Graaf notes that the impact of the potential vaccine news on stocks has produced an unambiguously positive signal for stocks, with his widely watched “thrust indicator” producing a buy signal for the second time in six months. This, he says, indicates that money is not just moving from one sector to another, but that funds are moving off the sidelines and rotating into equities as a whole, giving him confidence that stocks, and specifically cyclicals and small caps – should outperform into 2021.
Macro rotation MI2 Partners
3. Why déjà vu all over again would be quite a VaR shockJulian Brigden at MI2 Partners says that on a return on capital basis, the market moves by the recent vaccine announcements were unprecedented, triggering a VaR shock of monumental proportions (In particular the Pfizer vaccine news; yesterday was more muted). One shouldn’t underestimate this, and Brigden says this is an “all hands on deck” deleveraging event, that will cause fund managers to “sell what they have, and buy what they don’t have”, exacerbated by long exposure to US tech stocks. For this reason, Brigden expects rotation from growth into value to come early, whether vaccine discoveries really justify it or not. Only once the dust settles will there be time for reflection and nuanced argument, he adds. Indeed, Brigden has long discussed that secular rotation and change of leadership in the markets is most likely to happen in a “nasty” fashion. In other words, he says, the net longs and the growth sector overweights dictate that the market cannot cope with the first phase of de-risking and the first impulse for equities is down, not up. Brigden, being a macro guy, then considers what such a rotation implies for the wider asset universe, which says could see some significant mean-reversion across the board (Assuming the COVID crisis doesn’t blow out further, and some form of stimulus gets everyone through to mid 2021). Could we see US 10-year notes at 2%, not 1%, 30-years at 2.5%, not 1.5%? Where would NDX be then? Brigden says gold would hate higher nominal and real yields too (1,600, not 1,900), and countries like Italy or Spain could come roaring back (MIB 25,000, not 20,000, IBEX 10,000 not 7,000). As for EM, they too would come back into fashion, although EEM has already surpassed its January local high, adds Brigden. Energy could also come roaring back (XLE 60 not 30). This rhymes with the MI2 investment thesis since March, which has been heavily biased to a weak USD, weak bonds, real assets, strong cash flow and hard money. There are exceptions not aligning with that view of course. MI2 has been bullish on gold and the euro, and Brigden says it’s not clear how EURUSD fares in all the upheaval, but positioning (get me out!) won’t help the EUR short term if positions are forced shut indiscriminately.
momentum strategies Quant Investing Libra Investment Services
4. Is quant dead? Or just lost momentum? Long live quantThere is a continuing refrain that factor-based quant investing is facing an existential crisis, says Chris Tinker at Libra Investment. That said, this disguises the fact that, to varying degrees, all investors are “quants” now, Tinker adds. As he explains in this note, there are two ways to look at this. On the one hand, factor based quant investors are suffering yet another annus horribilis, while on the other “non-quant” investors are increasingly using timely and more nuanced data sets to improve their investment decision making. This, says Tinker, is set to lead to better, not worse investment outcomes for those who eschew the old-style quant models and embrace a more dynamic and systematic quantitative approach to their existing investment methodologies. Tinker expands on this dichotomous relationship to help explain why factor-based quant investors have seemingly run into a brick wall this past week from a VAR shock (as MI2 describes above), and the flaws inherent in the above mentioned ”old style quant models” used in momentum models. What has been revealed here is a structural issue for “quant investing” – it is not just about a change in market regime, argues Tinker. He thinks this failed strategy is now seeing stock-pickers turning to more sophisticated stock level data analysis and employing techniques such as Machine Learning in their own investment processes, where changes in expectations about future cashflows, margins, revenues or returns will potentially move the share price in the stock pickers favour and where quant techniques are now being focussed. What they are not using are the increasingly discredited factor models of the traditional quant world where, for more than a decade, the only factors that contained any company level information over and above price-based information seem to have failed to give any persistent benefit to returns, concludes Tinker. Libra built their models around stock level forward looking expectations and have recently published a paper on how momentum can actually be quantified and invested in as a fundamental investment factor using forward looking expectations data as inputs into their pricing model. Click below to request the note from Libra.
carry trade FX JP Morgan
5. The death of currency carry and the creation of viable FX hedgesLast week Deutsche Bank was extolling the merits of the carry trade for those seeking returns in FX, but JP Morgan’s Meera Chandan says it is best used by investors as a hedging vehicle. She points out an important feature of 2020 was the simultaneous and outsized monetary policy easing by central banks globally, which pushed the yield on FX carry baskets to record lows. This says Chandan means investors are unlikely to engage in yield seeking behaviour in FX and carry is unlikely to be a meaningful differentiator of currency returns. However, she says a corollary of low yields on carry baskets is that it has become substantially less onerous to be short high beta currencies, thus resulting in their emergence as viable risk market hedges. FX could thus see increased participation from proxy-hedgers as a result, says Chandan. As she points out, the carry cost to be short G10 cyclicals—NOK, NZD, AUD, CAD—is negligible. In particular, says Chandan, NOK and AUD stand out as their betas to equities over the past five years has been at par with EM high-yielders like ZAR, MXN and RUB, but the carry cost is a fraction by comparison.