Risk-Seeking Behavior Evident Everywhere by Charlie McElligott, RBC Capital
OVERNIGHT: All’s well, with risk-seeking behavior evident everywhere: Overseas, we see Brent crude reclaims its 200dma, Asian EM shows a number of equities markets breaking-out to YTD highs + (Kospi, Hang Seng, Nifty, SE Thai, with Jakarta Comp / Indonesia near all-time highs), DAX bouncing off 200dma and making a new YTD high as we speak, while FX momentum factor continues working, as evidenced by the DB G10 FX Carry Basket +1.4% since the start of August. And it goes without saying that EU and UK credit markets are ‘en fuego’ (the good-kind), with bond traders riding on the coattails of the respective central bank buy programs (FT highlighting BAML data showing Sterling corporate bonds note: the ECB’s CSPP purchase update yday showed a total of 509 corporate bonds now purchased at a total amount of E377B….and get this: 25% of the 509 bonds that have been purchased thus far are negative yielding). Globally, the corporate bond issuance record for August was already broken…after the first week of the month alone.
Turning to demand for “all things US” (=levered to the US “relative growth machine” with a USD currency kicker), especially in front of the Summer holiday “shut-down”: US HY issuance remains white-hot, with another 4 offerings yday for the busiest day ($3.5B) since June 13th, while US IG continues its comical run, with another 12 deals yday raising $11.8B. On the US equities-side, there were at least 15 deals done last night around $5B, in what I’m told was the busiest night (in # of deals) since mid-2015.
AND WHY WOULDN’T IT BE? Economic “surprise” indices measuring the trajectory of the data show major developed economies running at 2.5 year highs (global PMI ‘new orders’ at five month highs as an example of this ‘strengthening’ indication with a forward-looking tilt), while the EM surprise index shows at 1 year highs. Many on the buyside have now been “forced-out of their bunkers” after being meaningfully underexposed to a rally, let alone one that is “cyclical growth” in nature (more on that later). Most clearly though, central bankers have escalated their market interventions to now-record levels of aggregate buying (with BoE about to again join the fray as well), alongside ongoing NIRP and increasing fiscal stimulus policy discussion (BoJ assessment along with Canadian and Korean action as notables). Ben Bernanke actually piled-on yesterday to this messaging party, adding in a not-so-subtle 2 cents justifying / telegraphing the Fed’s most recent “dovish pivot” in a post on the Brookings website (http://brook.gs/2b7WnHJ):
“In particular, relative to earlier estimates, they (my edit: the FOMC members) see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited. Moreover, there may be a greater possibility that running the economy a bit “hot” will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.”
COMMENTARY: Shaking the cobwebs after two weeks of brain de-frag…and at first-blush when assessing the current state of the market, I see that very little has changed since I laid out the roadmap back in early July.
The largest risk in the market was that the “slow growth / low inflation” macro worldview was a dangerously consensual outlook (one that could get ‘tipped over’ with an “inflation impulse”—or even the expectation of one). The “slow growth / low inflation” view of course emboldened the enormous ‘long duration’ trade (outside of the forced buying from EU and Japanese “real money” in light of local NIRP policy crushing yields), while at the same time, we saw equities investors attempt to pile into defensive / “low vol” / bond proxies (STUB trade—Staples, Telcos, Utes and Bonds) as late-comers trying to chase performance in H1.
The “price is news” behavior of inflation equities (along with many commods, e.g. Cotton +17.4% QTD, Rebar +12.9% QTD, Iron Ore +10.6% QTD, XPT +11.8% QTD and XPD +14.9% QTD) evidenced a “wrong-footedness” of positioning that would be significantly exacerbated if we saw signs of job reacceleration and wage growth, as the potential for said “inflation-impulse” would catch the masses offside.
And if a broad risk asset rally were to occur, widespread “under-positioning” (with high cash / low grosses and nets) set up potential for more “kindling” on an upside move. Finally, we backed-it-up with the Quant Insight PCA framework, which signaled to us that a macro regime change was evident with risk-asset poster-child S&P 500 (the r-squared of factor drivers were no longer explaining the price action in the SPX), and that it was likely we were on the cusp of a binary move…which if looking at the evidence just re-presented, made a strong case for a risk / inflation tactical upside breakout trade.
Needless to say, a view of the landscape on a MTD basis is iterative of this scenario having in-fact played-out: growth, small cap, early cycle, HY, FANG, E&Ps, oil services, banks, indus, Internet, semis, materials are all driving the leadership / performance (see monitors below), and shows an impressive “grab” for a world not long enough of the right “growth” stuff. And mind you, this is just off the continued ‘firmness’ in CPI / PPI and wages, with no real breakthrough yet (and I have to note that this morning’s US NonFarm Productivity report showed a Q2 revision lower in “compensation per hour” that made for the weakest print in this category since 3Q14, so this reversal has to be monitored—H/T Dave Brickell).
Risk Thermometer Shows A Remarkable Move Into Growth-Y Stuff QTD / MTD: With “low vol” / defensive / “safe havens” as the source of funds.
Sub-Sectors Reiterate The MTD-Move Towards Economically ‘Geared’ Areas:
Sector Level, MTD-Focus:
So along with the aforementioned upside price-action in cyclical growth factors /sub-sectors / asset classes relative to the underperformance of “safe havens,” we now see signs from hedge fund positioning data that the wheels are indeed “turning,” as exposure is being taken up. Using US equities as a proxy for broad risk appetite, MS PB data had shown three consecutive days of buying to end last week, with Thursday being the largest net buy day in over a month (led by quant / stat arb funds), while Friday saw amongst the largest net buy days in both the (heavily cyclical) financials and industrials sectors on the year, led by L/S funds. Yesterday’s data showed net flat flows, but that the largest net buying was in consumer discretionary, industrials and tech—again, the right kind of sectors. GS PB data shows net exposure (north of 60%) and gross exposure (220%) trajectory at or making recent highs.
Trending / Themes:
EQUITIES: Cyclicals over Defense (from STUB to BUST? Thank you, I’ll be here all week). Tech, Fins, Energy leadership MTD, but still crowded in the mega-stretched valuation safe havens like Staples (GS notes “global consumer staples sector’s weighting reached its least underweight positioning since March 2011”). Factor-wise MTD, it’s value / quality / earnings revision / growth mkt neutral strategies significantly outperforming size / anti-beta / momentum m/n.
FX: Policy AND data-divergence themes reinvigorating USD (DXY) upside trades, while momentum factor has again been working since July (Aus Dollar / Japanese Yen stronger against the USD while Canadian Dollar and Sterling lower, for instance). RBC’s David Brickell notes though too a new dynamic: that the increased dialogue on ‘fiscal policy’ will allow the negative implications from “policy divergence” on the USD to be mitigated, as long as the US data continues to sit in this goldilocks spot. This in turn could actually see the expectations for stronger Dollar from stronger data negated as clients instead focus their efforts in “yield chasing” higher beta currencies.
LIBOR: Continues to run higher on account of the money market fund reforms set to “normalize” post Oct 14th implementation date. This without question creates financial tightening in the “plumbing” of the system, and US Rates Strategist Michael Cloherty’s view remains that this stress will keep rising through late September (until MMF’s can again get a sense of their redemptions to then extend their maturities out of the front-end). The situation has to be monitored, in addition to spill-over into other areas like cross-currency basis costs.
RATES: 1.61 level again holds in UST 10Y twice yday, and Treasuries continue firmer overnight despite supply. Flatteners still the medium-term trade of favor on the same “overseas yield reach” dynamics, but RBC’s Andrew Haynes notes that although this “yield-compression” remains in play, accounts are becoming “choosier” on entry points–as evidenced by the meaningful drop in demand for STRIPS from June to July, as UST yields dropped precipitously.
CREDIT: Energy credits are impressively holding-firm despite crude’s recent beat-down (see chart below on HY energy spreads <inverted> against CLA), likely on account of the ongoing “spill-over” effect from ECB buying and strong performance from distressed funds / ongoing inflows to those managers. Broad HY acting firm as well via the YTD strength in Telcos and Utes.
RBC’s Razzy Ghomeshi notes that investment grade flows are now more balanced relative to the one-way ‘buy’ trade we had been seeing over the past few months….especially with overseas accounts, some of which are now finally looking to monetize gains. But that said, still skewed better buyers in aggregate, and frankly in my view, with corporates showing such willingness to participate with rates here with the window remains open (to fund buybacks, divies and M&A) it’s impossible to get negative on risk-asset without an external ‘shock.’
Charlie McElligott
Managing Director
Head of US Cross-Asset Desk Strategy
