In a note published last week entitled ”10 Questions for multi-asset investors entering 2019” Goldman Sachs showed that their risk appetite indicator (RAI) currently shows that risky asset return asymmetry is likely improving, but only over longer horizons as current levels still suggest near-term caution may be needed Are positioning, sentiment and risk appetite really bearish now? The RAI tracks risk premia and pair trades across assets, and can provide a contrarian signal at extreme levels, albeit over long investment horizons. In the past Goldman have shown that the RAI tends to be the best predictor of positive return asymmetry when it reaches extremely low levels, with levels closer to -2.0 giving the clearest signal over longer time horizons. The RAI reached -1.9 at the end of December, but if one exclude safe havens, which have lagged during some of the ‘risk off’ given the inflection in yields, it troughed at -2.3. They have seen a similar signal sent by the VIX: historically, if the VIX spikes close to 50 it often signals a buying opportunity over a 12-month horizon. Furthermore, changes in US equity and bond futures positioning also suggest a decent de-risking, although there could be further to go. The note also pays some attention to technical factors too, which has been a point a debate among market participants and can possibly explain some of the price action. for instance, they look at positioning from systematic and quantitative strategies, and changes in liquidity, which could have exacerbated moves motivated by fundamentals.
DeepMacro uses algorithms determine the economic regime by looking at today’s combination of global growth, inflation, and risk appetites (both levels and changes), and finding the points in time in the past that were closest to the current state along these dimensions. The algorithm’s then maps the regime into expected asset prices. This mapping is based on how far today’s growth/inflation/risk readings are from the center of all the regimes. So the asset prices expectation is a sort of weighted average of the different regimes. The different regimes are represented by colours: “purple” (or “expansion”), “green” — (or “vulnerable”), ““red” (or ”goldilocks”), Orange (“Transition”), Blue (“Trough”). For January Deep Macro’s model sees a transition from the “purple” (or “expansion”) regime to the “green” — or “vulnerable” — regime. Click here to view a 3D graphic in motion of the DeepMacro Regimes Visualization (Dec 2003 – Dec 2018 with the Star representing the most recent point). The biggest worry is that trends in market risk appetites are negative. This results in an equity position that is meaningfully underweight (relative to common reference indexes, such as a market cap weighted index), but not all the way down to zero. DeepMacro’s interpretation of this suggests that the model is picking up on rising risks and the aging business cycle, which are reducing the upside potential for risky asset returns. Still, decent growth levels, low cost pressures, and a benign policy environment leads them to maintain some equity exposure.
One of the most read research pieces published by Deutsche Bank is their weekly Investor Positioning and Flows report, which provides extensive insight on cross asset positioning and flows. In their latest edition, Deutsche Bank says equity price action and repo moves suggest significant cuts in futures positioning, but low liquidity likely amplified market impact. DB note that while they do not have data for futures positioning from the CFTC since Dec 18th due to the government shutdown. equity futures positioning historically has been closely correlated with S&P 500 price action and repo (implied financing), and these relationships suggest positioning fell significantly in December. Also in the report, they highlight that gross leverage for L/S Equity is at multi-year lows, with 2018 being the worst year for L/S equity performance since 2011. On Systematic strategies, they observe that these strategies have very low equity allocations. Vol Control, Risk Parity, and CTAs have the lowest equity allocations since Aug/Sep 2015 when 1-month realized volatility was also above 30. Outflows from equity funds in December were the largest since 2008, mostly from the US and Europe, while Japan and EM continued to see inflows. They also note that there were massive inflows into money market and government bond funds, while heavy outflows continued from credit funds.
Highly polarised sentiment across assets is consistent with stretched levels of ‘risk off’, writes Absolute Strategy Research in the first edition of their weekly Sentiment, Positioning and Risk Essentials report for 2019. ASR measure sentiment using their proprietary Sentiment Barometer Indicators (SBIs), which use behavioural biases to create series that have the same dynamics as survey-based indices. These SBI indicator readings, when taken in an historical context can provide some useful guidance to investors. For instance on global equities, the readings versus bonds have fallen to SBI levels that in the past 20-years were followed by an average 0.4% rise in relative over 30 days. Meanwhile, in late December (24th) the bond/equity ratio SBI dropped to levels that in the past 10-years have been followed an average 50% rise in ML MOVE vs. VIX over 65 days and an 8% rise in US equities versus bonds in total return terms. On Credit, the US high yield vs. investment grade relative has also hit stretched pessimism territory, while on Rates, in absolute terms, US 10-year Treasury yields have fallen to SBI levels that in the past 20-years were followed by an average 6bps rise in yields over the next 20 days. On commodities, while gold has shone in recent weeks, activity exposed commodities, such as industrial metals and Cotton have struggled. ASR note that while stretched pessimism may lend some near-term contrarian support to industrial metals, negative momentum underlines the risk of further downside. Finally on volatility, G7 FX vol is overbought and the MOVE is elevated, according to ASR’s indicators.
Sentix is a world leader in investor sentiment data. Their data and reports are free to investors who take part in their surveys. Sentix’s indicators track where investor funds are headed, monitoring whether investors are loaded with equities or whether benchmark thinking is dominating the behaviour of institutional investors. Sentix also provides positioning data on equities and bonds, showing not just the averages abut also sub-indices showing how many market professionals are short or heavily overinvested. Investors can use that data to get an idea of what market developments could have the most severe impact on investor portfolios. In their first survey for 2019, from 998 contributing institutional investors, there has been a marked improvement in sentiment for US equities after the horror month of December. Sentiment for US blue chips rose to -5 percentage points, thus completely reducing the pessimism that had arisen the previous month, but Sentix say that it should be constructively assessed that there are no signs of euphoria, and the improvement witnessed here is early stages and still vulnerable to reversal. The survey also finds a turn in the strategic bias on European equities versus US equities. Turning to Sentix’s Overconfidence Index, which measures the probability for the case that a series of rising or falling prices has led to an augmented complacency among investors, the survey finds overconfidence among the bears in Japanese equities and oil, and the bulls on US and European bonds.
Falling oil prices and the dollar’s strength have allowed the Fed room to pause and allow the disinflation boom to once again drive equity prices, writes Sean Darby, chief global strategist at Jefferies, adding that the US bond markets appear to have come to the conclusion a little earlier. Darby thinks there is now a high enough proportion of stocks offering value versus government yields and cash to put a floor on share prices. As a result, Jefferies have upgraded the S&P 500 within the Global Asset Allocation today. While sentiment is fragile and 2019 earnings estimates have the hurdle of 2018 ‘base effect’ to overcome, Darby and his team have used some ‘old school’ measures to get a feel for how much value has been generated by the recent multiple compression and decline in long-term dated government bond yields. Although we appreciate that investors have been nursing scars from the recent volatility, there is a natural tendency to either go back and own the shares that have previously been held or to go ‘defensive’. However, as Darby pointed out in another note last week (US: Multiple Mathematics) it has not necessarily been changes in earnings estimates or economic data that influenced share prices but changes in short and long term interest rates. Jefferies say there are three possible methods to look at shares with an eye on value: 1) Observe companies based on long-term financial metrics and market multiples, 2) the S&P 500 PEG ratio has fallen back around 35% from its peak in this cycle and is trading just above its 2011 lows, 3) Jefferies highlight those companies with high net cash to market cap. Although the US did not necessarily have as many companies as other markets, Jefferies say there were enough to build a base of ‘cheap stocks’.
The 100bps RRR cut in January signals counter-cyclical easing of monetary policy to arrest the downturn, writes Standard Chartered’s China economics team. They say that the PBoC appears to be aiming for M2 and credit growth in line with nominal GDP, to keep leverage stable. While fiscal policy (via tax cuts and spending increases) will likely do the heavy lifting, StanChart say the central bank has been asked to keep liquidity ample and market interest rates stable. They estimate that net liquidity injection in January will be at least CNY 1.1 trillion, sufficient to meet cash needs ahead of the Lunar New Year holidays and accommodate an early start of government bond issuance. StanChart now expect another 200bps of broad RRR cuts for the rest of 2019 (300bps in total this year), allowing M2 to grow 8-9%, in line with nominal GDP. They had previously expected a total of 200bps of RRR cuts in 2019. The PBoC’s balance sheet will likely shrink as the outstanding MLF balance declines; more RRR cuts are therefore needed to compensate for the erosion of the monetary base.
In their third annual thematic Global Surprises report, CLSA lay out 10 big picture ideas that they believe are not priced and so could potentially move the market. CLSA’s analysts suspect Sino‐US trade concerns will dissipate and the market’s focus will turn to military and tech dominance. A global bear market will begin, or be confirmed, and bitcoin may outperform the S&P 500. Similarly, China’s CSI 300 can outperform the S&P 500, while the RMB:US$ could move through 7:1. Walmart looks set to outperform Amazon, while robotic‐process automation and metal 3D printing will see success. Most controversially, they think we could see Trump’s early exit as US president.
Goldman Sachs commodity strategists believe that the volatility and magnitude of the oil sell-off late 2018 was exacerbated by technical trading factors. Through $60/bbl Brent prices, the decline was driven by negative gamma effects, and beyond that, the move was driven by trend following selling flows into a greater than seasonal year-end collapse in liquidity, as uncertain fundamentals led to a dearth of corporate and discretionary investor trading. So as volumes have recovered this year, so have prices. Looking at where oil currently trades (WTI $47.5/bbl when this piece was published), Goldman argue that the oil market has priced in an excessively pessimistic growth outlook, which they say sets the stage for prices to recover as long as global growth does not slowdown below 2.5%, even if it were to fall short of their growth forecasts. They see oil as fundamentally undervalued. Furthermore, despite the increased macro uncertainty, Goldman analysts have only made a modest 60 kb/d downward revision to their demand expectations, which they had already reduced in early December. So if growth disappoints further, they believe that it would only take a modest sell-off from current levels to incentivize offsetting supply adjustments from OPEC and shale. Their 3 and 6-month Brent price forecasts are now $62.5/bbl and $67.5/bbl, down from $70.0/bbl previously but still above market forwards. Their 2019 average forecasts are $62.5/bbl for Brent and $55.5/bbl for WTI with their 2020 respective forecasts unchanged at $60.0/bbl and $54.5/bbl.
The US is taking steps to centralize supervision of China-related technology policies, with Congress proposing the creation of a new office to track transfers of emerging, foundational, and dual-use technologies and to protect supply chains. The Commerce Department is also moving to develop a list of restricted emerging technologies that includes artificial intelligence, robotics, and quantum computing. Clearly defining national security concerns relating to new technologies is a complex task; there is a significant risk that administration hawks will take a too hasty and broad approach, with negative effects for the technology sector globally.