From Charlie McElligott, Managing Director, cross-asset strategy at Nomura
2017 REDUX, AS ‘GROWTH SCARE’ IS OUT, FED NORMALIZATION IS RESUMED = RISK ON, VOL SMOKED
Summary (more or less):
- 2017 all over again as cross-asset vols are crushed—why?
- Perception of “growth scare” evidenced over the past month (disappointing global growth / outright BAD EU data) now seeing a nascent ‘calming’ / sentiment pivot back to expectations for “mean-reversion” HIGHER in economic surprises
- Last week’s US inflation data shows strong PPI trend and YoY core CPI above 2% (but not “too hot” either), along with this week’s US Retail Sales and IP beats (plus inline Chinese GDP and better Retail Sales) acts to ‘cool’ recent slowdown fears
- Resumption of US inflation (and broad) U.S. data confidence / stabilization = again “pricing-in” a more aggressive Fed
- Thus, the powerful yield curve flattening of the past two weeks extends, as the front-end continues to sell-off against both foreign and domestic RM drive long-end buying (lots of cash which still needs yield), wrecking the recently popular tactical macro steepener trade
- Credit another strong day, with six high-grade issuers pricing $13.6B of issuance consumed with negligible concessions, massive compression from IPT and large orderbook oversubscriptions—reiterating “hunt for yield” with return of low vol / carry market
- Systematic CTA Trend community again adding SPX exposure with resumption of momentum—potential for additional +$14B of SPX to buy if we close north of 2718
- Surprise, surprise—Earnings tailwind drive legacy equities “Momentum” positioning (and broad index strength), with “Secular Growth” longs massively outperforming “Cyclicals” and “Defensives” = great day for both equities Hedge- and Mutual- Funds
- “Secular Growth” (i.e. Tech) is the biggest winner of the “Fed sweepstakes” (stuff that can “grow” despite tightening) and CONFIRMING what we said after Powell’s Fed presser: equities wants ongoing Fed policy normalization (more “hawkish” than “dovish” on the margin) as a sign of confidence that better growth will drive higher a “neutral rate,” making the overall move higher in interest rates “manageable” for stocks
- Tactically, “Cyclicals” can still work too, as a “growth-ier” worldview is driving further rally in commods complex: Crude +1.4%, Copper +2.2% already today
- Final point on equities which fits my view of “tactical melt-up” in cyclicals- and inflation-linked risk assets thesis: thematic “glide path” likely ahead, as historic Nomura 1Y Momentum Factor seasonality shows a “pivot” off the March / April “reversal / unwind” lows and breaks higher over the next 3 months–May (best month for “Momentum” in post-GFC period since ‘10), June (3rd best month) and July (2nd best month) string together quite a +++set-up coming out of EPS season
Risk markets are again “melting-up” as the perception of a “global growth scare” evidenced over the past month via the slowdown in data trajectory is now viewed as “calming,” coming off the back of last week’s U.S. inflation data and bounce in Retail Sales & IP prints, alongside steady Chinese GDP and a beat in their own Retail Sales.
As markets are again seeing confidence is this “resumption of U.S. inflation- and growth-” story, we are again pricing-in a more active Fed normalization—as evidenced by the below chart of market expectations for 2018 Fed hikes going to new highs (spread btwn Apr ’18 / Jan ’19 FFF):
Thus, as yield curves have resumed their violent flattening, cross-asset vol & term structure too is being smoked.
CROSS-ASSET VOLS SPANKED BACK TO JANUARY LEVELS:
As confidence in inflation expectations is restored, breakevens widen alongside a stronger commodities complex / higher equities.
RESUMPTION OF CONFIDENCE IN U.S. INFLATION SEES BREAKEVENS AGAIN TESTING MULTI-YEAR RESISTANCE LEVEL:
HIGHER BREAKEVENS / HIGHER COMMODITIES / HIGHER NASDAQ:
Stocks are currently benefiting from the telegraphed ‘calm’ of earnings season, as headlined by the massive performance boost across both MF and HF via the NFLX “halo effect” (huge outperformance day for MF’s yday, while HF’s saw a good day but obviously with shorts squeezing as a performance drag). In turn, consensual positioning long ‘secular growth’ against underweights in ‘defensives’ and ‘cyclicals’ benefitted tremendously, which due to the enormous weighting of the Tech sector, took broad index with it.
U.S. EQUITIES PERFORMANCE YESTERDAY ADDS FURTHER NET LENGTH:
This multi-day index-level “gap higher” is critical, because it has again drawn-in the systematic community as an INCREMENTAL BUYER after turning seller over the past month. Per Nomura Quant Strategy’s CTA model, SPX exposure has gone from 33% up to 42% “long” over the past week. And there is more ammo from here, as a close above the 2718 level tonight would see an additional +$13.5B of SPX buying, getting them to +54.5% “long”:
So taking this all back to the original points made on the “resumption of above-trend inflation- and growth-“ perception: equities price-action tells us that they want ongoing Fed policy normalization (more “hawkish” than “dovish” on the margin) as it relays confidence that higher interest rates are going be driven by “growth” (a higher “neutral rate”).
This was the point I was making after many were left scratching their head regarding the equities weakness following Powell’s first Fed meeting. Many (especially in fixed-income) were surprised that stocks sold off on what they perceived to be a “hawkish” message. My view was that across equities, it was viewed actually as incrementally more dovish than what was expected, especially with regards to his downplaying of the Fed’s own economic projections.
Tech in particular is a “winner” when the Fed has inflation- and / or growth “ammo” to get more hawkish, as it can “grow” EPS despite tightening financial conditions which eventually will slow the “cyclical” economy.
Want some evidence? Look at the chart below of the earlier “expectations priced-in for remaining 2018 hikes” against NFLX–
U.S. EQUITIES ‘STATUS QUO’ SHOWS NFLX (PROXY FOR ‘MOMENTUM’ / ‘TECH’ / ‘SECULAR GROWTH’) WANTS FED HIKES AS CONFIRMATION OF GROWTH:
And similarly, the “expectations priced-in for remaining 2018 hikes” chart against equities “growth” proxy “PEG” factor:
YOU CAN SEE THE SAME RELATIONSHIP OVER THE PAST YEAR WITH THE “2018 HIKE EXPECTATIONS” CORRELATION TO EQUITIES “GROWTH” METRIC (PEG FACTOR):
So now one final point on where this goes from here, which fits nicely into my view of a “tactical melt-up” of inflation- / cyclically-geared- assets “thesis” (in typical “late cycle” fashion): there is a thematic “glide path” likely ahead, as historic data on the Nomura 1Y Momentum Factor seasonality shows a “pivot” off the March / April “reversal / unwind” lows and breaks higher with the best three months of equities “momentum” in the post-GFC period coming over the next three consecutive months–May ( the best month for “Momentum” since ‘10), June (3rd best month) and July (2nd best month)…all in, stringing together quite a +++ set-up coming out of EPS season along with the resumption of buyback.
HERE COMES THE ‘MOMENTUM SNAPBACK’ WITH THE THREE BEST MONTHS OF EQUITIES MOMENTUM IN THE POST-GFC PERIOD (’10 ONWARD) COMING OVER THE NEXT THREE CONSECUTIVE MONTHS: