After a stellar quarter for US equities, stocks have unexpectedly slumped on the first day of Q2 despite "whispers" of pent upmutual fund reallocation into risk assets that would take place today.
So why are stocks lower, besides "more sellers than buyers" and "money going back to the sidelines" of course? For a comprehensive assessment of what is going on below the surface, here is RBC's Charlie McElligott (who as a reminder warned on Friday about the Double Whammy in the April Effect) looking today's rates reversal, the shift to "anti-beta" leadership and the "momentum factor" reversal, all of which explain the bad start to the second quarter.
RATES REVERSAL, 'ANTI-BETA' LEADERSHIP AND 'MOMENTUM FACTOR' REVERSAL WITHIN EQUITIES NOT GOOD START TO Q2
Summary
- Kind of the start to Q2 that I was exactly highlighting in Friday’s note, i.e. rates reversing fueled by softening ‘soft’ data vs ‘prices paid’ overshoot, helping to ‘kick off’ a reversal within equities ‘momentum’ longs as ‘growth’ names fading,’defensives’ lead and ‘reflation’ is again hammered.
- Early focus on the big ‘Prices Paid’ beat in today’s ISM (highest absolute # since ’11), with S&P futures at lows on the session following the release indicating ‘bad inflation’ concerns when weighed against signs of ‘slowing growth’ (Street Q1 GDP downgrades, Atlanta Fed GDPNow downticking, Markit comments on Q2 post Manu PMI release) and weakening ‘soft data.’ This harkens back to the post Dec Fed concerns around ‘stagflation’ potentials and / or ‘hiking faster than we’re growing’ fears…i.e. Fed “policy error.”
- Firmer USD (“policy divergence” and start of new Japan fiscal year highlighted below) is meagerly attempting to keep US rates from breaking dangerously lower (recent move lower fueled by the leveraged fund short-squeeze in USTs turning now to interest in establishing LONGS), but this week’s heavy econ calendar will also have fundamental impacts.
- Today’s US data update is showing us that the much-focused-upon ‘hard vs soft’ data dynamic is showing signs of a ‘true-up,’ with the scale of ‘soft’ data survey beats reverting modestly lower (also see the ‘forward looking’ quote below from Markit’s Chief Business Economist—“…the loss of momentum seen in February and March bodes ill for the second quarter”).
- As per Friday’s note, on watch for signs of April’s ‘momentum reversal’ in equities, which would have large negative impact on buy-side performance as per the heavy overweight in ‘growth’ and the factor crowding in ‘market’—i.e. long books are very ‘high beta’ right now. RIGHT NOW, WE SEE ‘MOMENTUM’ MARKET-NEUTRAL DRAGGING LOWER.
- Current glimpse at session-performance shows us leadership from ‘defensives’ / ‘low volatility’ / ‘anti-beta’ which certainly isn’t helpful for the buy-side majority. Initially the ‘new safe haven’ of ‘growth’ held, although as Tech slips further back on the S&P sector performance tables, we see ‘momentum’ fading as well. Bringing up the rear we see ‘cyclicals’ / ‘value’ getting properly hammered as the aforementioned ‘duration sensitive’ sectors rally, as ‘reflation’ takes another hit.
- To see ‘anti-beta’ outperform against a buy-side universe so ‘long beta’ (‘market’) isn’t a ‘feel good’ indicator for the start of Q2…especially with ‘reflation’ / ‘value’ dragging lower as well and most-notably performance bell-weather ‘momentum’ fading too.
Details
- Historically, this first week of April has been a positive one for risk-assets / higher USD and higher US rates. Why? It might have something to do with the start of the Japanese fiscal new year. Into year-end, yen repatriation flows drive higher yen / weaker Nikkei, lower USD and US rates. In theory, the commencement of the new fiscal year in Japan reverses that flow, and thus, the pivot to weaker yen / higher USD / higher Nikkei and higher US rates.
So, we now have this additional short-term driver contributing to USD strength, which is proving to ‘hurt’ those who had recently flipped-short per what had been the nascent ‘policy convergence’ narrative. The issue of course was that last week (as we predicted the day post-Fed) FOMC members--especially doves--rolled out ‘hawkish’….while late last week, a number of ECB speakers (Nowotny, Praet and Knot) were seemingly forced to walk the ‘dovish’ plank. So, just as Euro longs were being built by tactical funds and shorts slashed / covered (CFTC speculative positioning least net short since May 2014), we saw the EURUSD drop from 1.0906 highs last week to its current 1.0665 level….OUCH.
- So for now, the near-term narrative has shifted back to the “central bank policy divergence” story as the ‘chief USD-driver.’ That said, this week’s very heavy US econ data calendar will have a role to play too with USD and with US rates as well, especially with the profoundly ‘cleaner’ rates positioning of late, following the enormous leveraged-fund UST short-cover spree of the past few weeks against the ‘lumpy’ asset-manager long selling seen in 5y and 10y.
Where we are NOT seeing less-extreme positioning is the front-end, as the spec net positioning in 3m Eurodollars goes even deeper to another new record net short:
The above positioning seemingly speaks to confidence on more hikes coming down the pipe from the leveraged fund universe. However, as my colleague Mark Orsley points out this a.m., there have to be some hedgies sweating their ED$ shorts a bit following 1) Fed’s Dudley dovish interview with Bloomberg over weekend…while at the same time, we’re 2) seemingly catching-hints of the long-awaited “true up” between HARD VS SOFT data divergence as expressed by indicators such as the Atlanta Fed GDPNow GDP Forecast (hard-data focused) turn MARKEDLY LOWER, while numerous Street economists reduced Q1 GDP numbers (RBC from 2.5% to 2.0%); Mark also speaks to 3) strong ED$ April seasonality as well and 4) bullish ‘inverse head and shoulders’ in EDZ8 and a bear-flattening ‘head and shoulder’ in EDZ7 / EDZ8 curve.
- The Markit US Manu PMI released earlier touches on this “SOFT VERSUS HARD” data dynamic—here are the comments from Chief Business Economist at HIS Markit Chris Williamson speaking to the thought I’ve been pushing on the likelihood of the ‘soft’ survey beats likely to ‘mean-revert’ down to hard data:
“The post-election resurgence of the manufacturing sector seen late last year is showing signs of losing steam. Output growth slowed to a six-month low in March, optimism about the outlook has waned and hiring has slowed accordingly.
While the survey data suggest that the goods producing sector enjoyed a relatively good first quarter on the whole, the loss of momentum seen in February and March bodes ill for the second quarter.”
‘SOFT’ BEATS Z-SCORE SEES DOWNTICK FOLLOWING THIS MORNING’S U.S. DATA DUMP:
US stocks today all about watching for sub-index level signs of ‘April Effect’ commencement (as per Friday afternoon’s “Big Picture” note). There will be certain buy-side ‘performance pain’ IF the market was to see a perpetuation of the ‘recent’ April ‘momentum-unwind’ phenomenon, largely on account of 1) ‘crowded longs’ (and thus with significant ‘momentum’ attributes) being so heavily ‘growth’-weighted (tech, biotech, cons disc) and 2) significant ‘market’ factor crowding risk in long portfolios, i.e. longs are exceedingly ‘high beta’ right now (‘High Growth’ basket raw beta to SPX = 1.25, adjusted beta 1.16; ‘S&P Info Tech’ sector raw beta to SPX = 1.20, adjusted beta to SPX = 1.14; ‘High Hedge Fund Concentration’ basket raw beta to SPX = 1.19, adjusted beta to SPX = 1.13).
Today as noted in the summary above sees ‘duration sensitive’ sectors like ‘defensives’ / ‘low vol’ / ‘anti-beta’ as the clear outperformers, with the ‘new’ safe-haven of ‘secular growers’ like Tech holding modestly well initially, but fading currently.
Also from a risk sentiment perspective, it’s notable that the bounce seen last week in ‘reflation’ plays i.e. ‘cyclical beta’ and ‘value,’ which in light of seeing GDP #’s taken lower around the Street currently likely shows further pain to come with rates rallying.
So, ‘growth’ poster-child ‘tech’ is now slipping lower, and as such, so too are ‘momentum longs’ fading. In conjunction ‘anti-beta’ outperform against a buy-side universe so ‘long beta’ (‘market’) isn’t a great indicator for the start of Q2, ESPECIALLY with ‘reflation’ / ‘value’ being hit.
MODEL EQUITY L/S PORTFOLIO SUCKING WIND HERE WITH ‘WRONG LEADERSHIP’ FROM ‘DEFENSIVES’ AGAINST ‘GROWTH’ LONGS—AND THUS, ‘MOMENTUM’--FADING: