Global equities rose 2.1% over the past week on the back of US leadership, with the S&P and Russell rising 2.5% and 4.3%, respectively. Europe (+2.9%) and Japan (+3.3%) were also notable gainers, but Asia ex Japan lagged, with China finishing roughly flat and Emerging Markets in the red.
Breadth was strong in both the US and Europe, with nearly every sector rising for the week – though we should note that US technology lagged the market, which is notable given that is has been the top performer for the past five weeks. Some of the large cap technology charts look quite daunting, which may be an indication that the market is losing its leadership in the most recent move.
Sector ETF flows were marginally higher, with the largest inflow into utilities and energy, while financials and consumer staples saw a $485mm and $350mm outflow. The remaining sectors were largely unchanged.
The dollar was 28bps higher on the week and global rates were largely unchanged. Crude was 5.4% higher and lumber paired some of its recent gains, falling 2.6%. Base metals and aggs were both lower, while cotton was a standout rising 3.4%.
It was an interesting week, with retail sales putting up the worst print since 2009, yet the market rallied higher. We pointed out three weeks ago that retail sales would likely disappoint to the downside given the sharp draw down in credit card transactional data. While market participants have argued this is a one off, we would point out that the credit card data for January is also showing a continued slowdown YoY.
We are at the point of the cycle where consumers use cash flows to pay down outstanding debt, thus halt spending, or miss the payment altogether. This is why you see a divergence between income growth and spending prior to a recession.
So far our operating thesis for this year has played out, albeit in the US equity space over the past two weeks, as the SPX has overshot our upside target — though global equities, specifically EM and China have begun to weaken.
We noted two weeks ago that the EM trade is extremely crowded due to the belief that China’s stimulus efforts will stimulate the global economy and drive upside in EM, which we view as incorrect until M1 turns higher. We saw over the past week from BAML that EM is now the most crowded trade.
Interestingly, commodities have performed well over the past few weeks, which leads us to believe that stimulus efforts may be coming through the pipes, but we are still not getting confirmation from rates, as shown below by China’s 5yr vs copper. We need to see Chinese rates turn higher before turning positive on the chance of a global growth upturn.
We also got Chinese M1 this week, which continued to slow. It is very difficult to be positive on global growth with M1 not moving higher, as it leads the economic data by roughly 9 months. We would note that Chinese import data strengthened in January to 2.9% YoY vs. estimates of -1.9%, though there is a high probability that this was due to the timing of the new year, as demand got pulled forward. Something to watch.
Europe, which is also highly interconnected with China, continues to see downward pressure on the industrial side.
And South Korea, China’s largest trading partner just saw the largest increase in unemployment since 2009.
To us, the most recent move in the US markets looks to be driven by offsides positioning and the re-emergence of risk parity. Towards the end of last year we thought the managers that de-risked (OW equities from 31% to 15%) would chase the market higher as it bounced. While there is clear chasing and a substantial change in bullish sentiment, BAML notes that managers reduced their OW equity position to 6% OW, thus increasing cash.
We can see that hedge funds were part of this crowd as their beta to the market has fallen materially.
And ETF flows indicate participants continue to be sellers vs. buyers.
So who has been the buyer? Risk parity. As you can see below, the risk parity index is close to all time highs as volatility has been crushed. We have also seen risk parity beta pick up over the past two weeks.
Shorts have also contributed to the move higher, as shown below by our most shorted index vs. the SPX. Note prior large covers.
So the market backdrop we’re currently looking at is trend/vol strategies along with pain from shorts driving the market higher, while on balance, more fundamental driven strategies are reducing exposure. This creates a situation where both participant groups can be off-sides, leading to strong move in either direction.
We should also point out that rates are not confirming the move in equities, as US, JP, and DE 10’s are near the lows while ACWI and SPX are close to prior highs.
We’ve been in the camp for lower prices over the past few weeks as % returns from 20-100 days for nearly every sector are in their 99.9th percentile, while some return profiles have not been seen this cycle. That said, we respect the markets move and must constantly adjust our footing. We are still pretty firm in our view of rates heading lower, as our thesis from Bonds and Chill continue to play out.
As we touched on briefly above, we are starting to see some weakness in technology, as shown below by the divergence between the SPX and AMZN, which is likely being weighed down by deteriorating retail sales data.
Google is also negatively diverging, and taking a step back, we can see the weekly is quite unattractive as well, with a rejection on the bottom of the LT channel.
And Microsoft looks ready to roll over.
Given our work, we are more convinced equities are likely lower 2-3 months from now, but the price action has been anything but bearish. That said, the shorts are worn out, the risk parity crowd has a tough VIX level to break through, and HF’s likely have some staying power here over the next few months. The incremental buyer, or a further chase given the cash on the sidelines is less probable in our view, but we are open minded to another 3-5% leg higher.
Have a good week.