Goldman: Imagine You Were Stuck On A Deserted Island For The Past Couple Of Years
By Tony Pasquariello, global head of hedge fund coverage for Goldman Sachs’ Global Markets Division
Imagine if you had been stuck on a desert island for the past couple of years. when back at your control center, you ring up GS for a quick check-down on what you (and, your trusty pal Wilson) missed while lost at sea. towards the end of the narrative — which details the greatest economic collapse since the Depression, followed by the fastest economic recovery in American history — your coverage person highlights a few present-day realities:
over the past 16 months, the Fed’s balance sheet has essentially doubled … having grown from $4.2tr to $8.0tr.
over the same time frame, US fiscal spending has totaled $9.1tr (including $5tr of COVID relief) … creating a Federal budget deficit equivalent to nearly 15% of GDP (for both FY’20 and ’21).
the US equity market has surged to all-time highs, resulting in a market cap equivalent to a full 276% of US GDP, also a record high.
given that backdrop, perhaps you wouldn’t be totally surprised by some other eye-popping factoids:
led by a pack of highly emboldened retail traders, a basket of widely held equity shorts would be up 46% YTD — or, more poignantly, +323% off the lows of March ’20.
the stock market would feature record high levels of new issue — be it through IPOs, secondaries, convertibles or an acronym you hadn’t heard much about before you set sail.
the US housing market would find itself in a state of record high prices and record low inventory.
now, given all of that, you rightly ask: so when did that QE bonanza end and where are we in the hiking cycle?
after a long pause, your coverage politely tells you that QE is still very much going on — to the tune of $120bn bonds per month, including, perhaps incredibly, $40bn of mortgages — and, that the brightest economic minds in the Firm don’t expect the first rate hike until … 2024 (link; this piece is worth scrolling through).
at that point, while you’re probably wishing you had access to your Bloomberg terminal over the past few years … while glad that one of the books you had to read on your desert island was Morgan Housel’s The Psychology of Money:
“we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance). physics isn’t controversial. it’s guided by laws. finance is different. it’s guided by people’s behaviors.”
what’s my point here? I think there’s a lot wisdom in that quote. yes, the points below are mostly well grounded in economic architecture and common sense. that said, given the enormity of the forces that have characterized the past 16 months, who really knows where this all ends up … at the very least, it pays to be open-minded on the terminal outcome, I’d argue with a skew towards the right tail in certain asset markets.
what follows from here is a handful of quick thoughts on the economy and the markets, all connected with a chart:
1. it may not matter today — as we experience a surge in US economic output that may well never be seen again — but, as markets look around the corner, it’s worth noting that by the end of next year — and, in the years that follow — GIR forecasts that we’re back into a growth environment that’s very reminiscent of the post-GFC secular stagnation era (link). this provokes two thoughts:
i. I will stop short of saying it’s time to cut-and-run on the cyclical trade, but again I reckon this argues for ongoing balance with the other foot in secular growth exposure. said another way, this would be a friendly backdrop for mega cap tech. and, as detailed in the subsequent couple of points, there are cyclical parts of the market I still really like … while I’d be increasingly skeptical of spaces like brick-and-mortar retail (framework available).
ii. at first glance, I admit this glide path savors of anti-climax. then again, it could well be just what the doctor ordered for S&P. I say this when thinking back to Bill Dudley’s call for 3-4% interest rates … through the prism of the stock market, I think you’d much rather have the Fed attempting a soft landing than trying to cool down an overly hot and tight labor market (remember the old rule of thumb 2).
2. while it’s admittedly on a short leash given the prior point, I still like the European equity trade. the thesis is clear-cut: SX5E possesses the core cyclical properties that fit the current growth backdrop … GIR is confident on the strength and sustainability of the Euroland growth rebound (link) … and, it feels to me like the market is underappreciating the significance of the Recovery fund. with credit to Jari Stehn in GIR, the chart on the left shows the total size of the Recovery Fund allocation in percent of GDP — and, the right chart shows the estimated impact of the Recovery Fund on the level of GDP … for southern Europe, in particular, these are not small figures:
3. commodities: following on from there, should one want to stay one other cyclical ride, I think there’s an argument for accentuating the commodity-centric plays. if GIR’s Jeff Currie were teaching a course at Macro University, the first day of class would start with the following level set: most financial assets are anticipatory in their discounting of the future, while commodities are anchored to the brutal truth telling of supply-vs-demand. having been on a number of recent calls on this topic, a few things stuck out to me, followed by a simple 10-year chart of BCOM:
i. yes, big picture, the supply and demand story for commodities is still superb. in our work, incorporating the key elements of ESG and governmental focus on inequality, these are the early innings of a secular bull market. if that’s correct, use pullbacks for location to add structural length.
ii. more tactically, there seems to be a major wedge between sentiment and positioning (especially by the younger trading crowd). for example, note that length in copper today is the same as it was last summer. bigger picture, it’s just not that big an asset class relative to almost all of the other arrows in the macro quiver.
iii. if oil keeps flying along this summer — which is not a crazy thought given how tight that market will likely feel — perhaps it becomes that flickering red light on the dashboard that compels asset allocators to feel the inflation pinch a bit, resulting in an increased allocation to commodities for the first time in a long time.
4. the ongoing collapse in S&P realized volatility is not something I totally expected. as you can see here, 3-month realized is not so far off where it was in the really boring macro years circa 2016, 2017. well, the truth hurts: variance swap short sellers 1, Tony 0. my instinct remains that the base level of implieds should remain higher than the prior cycle given the potential for a high rate of realized volatility in the actual economy, and an ongoing hope that 10yr note yields will awaken from their recent slumber. said another way: vol down here is a buy, not a sale, and I’m happy to own the wings at current prices.
5. while the hunting has remained pretty decent in macro land this year, the degree of difficulty involved in managing fundamental long/short money has grown enormously (n/b: I’m bullish the strategy for the next phase of this cycle). if I were to paint one illustration of what’s been so difficult about the recent period — and, I reckon, is not sustainable — it’s this: the white line is Russell 3000 … the green line is the hedge fund VIP basket … and, the red line is a basket of widely held short names:
6. I admit to having a soft spot for the year 1995: in the first half of the year, I was a senior in high school … in the the back half of the year, I was a freshman in college … along the way, S&P rallied 34% and NDX jumped 43% 3. given that affinity, I was happy to see a client claim that the best overlay for YTD 2021 is … 1995:
7. one factoid for the road, if only for the most tactical of traders … I find this Fed report on the overnight drift in S&P futures to be crazy interesting: “over the last twenty years, overnight returns have been large and positive between 12 a.m. and 3 a.m. U.S. Eastern time. indeed, the full overnight trading session, that is, the trading between 4:15 p.m. and 9:30 a.m., has on average generated 2.6 percent annualized returns, constituting more than half of the 4.3 percent annualized close-to-close return during our sample period. moreover, most of the overnight return occurs in the window between 2 a.m. and 3 a.m., when the European stock markets open. in contrast, the opening of the U.S. market at 9:30 am is preceded by large negative returns, a pattern we call ‘opening reversal,’ with returns continuing to be negative on average until 12 p.m. intraday returns are then roughly flat until 3 p.m., and are only positive on average during the last seventy-five minutes of trading prior to the closing of open outcry futures trading at 4:15 p.m.” (link). said another way: buy the close, sell the open.
2 – there has never been an increase in the unemployment rate (measured in unrounded terms on a 3-month moving average basis) of more than 35bp that wasn’t associated with a recession. credit to Jan Hatzius, GIR.
3 – note these returns in NDX that followed: +43% in ’96 … +21% in ’97 … +85% in ’98 … +102% in ’99.
Mon, 06/14/2021 – 18:00
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