A basketball fan?
A sneaky little reference to the NCAA basketball elimination tournament that runs through March in the USA, the betting on which is a popular pastime on trading floors through March there. However, it also is an apt title for this week’s blog, because the March rally in global markets has been described as madness by many, particularly those who didn’t participate.
Since we blogged about the interesting juncture that markets were at in late February we thought it was appropriate to revisit what we said about the what was needed to for the rally to continue, but also now to look at where to from here.
How ‘mad’ was it?
The quantify the size of the rally, in USD terms, MSCI AC World, the broadest index of global stocks, was up 7% for the month. Emerging markets were up an even more impressive 13% for the month, as they benefitted from a weakening USD, with US and Europe markets the ‘laggards’ up less than 7% in USD terms.
Unfortunately for Australian based investors, the surge in the Australian dollar of over 7% in the month, meant that returns in local currency terms masked the scale of the move.
How did it line up with what you wrote in your blog?
We outlined 4 objectives that needed to occur in our mind for the rally to carry on from February into March. Recapping those:
1) Oil to stop falling, preferably range trade around $30-40: We got this, with this range holding over the month, if anything to the upper end of that range
Chart 1: Brent Crude Oil
2) Defaults to not have all occurred: Too early to tell, with only 4 weeks of data, but the move in high yield markets was very positive over the month and issuances re-started with WDC looks like getting a large issuance away at the moment, though at higher price, but the window is not shut
3) US Dollar to not have gone up: This was in our view the biggest driver of this rally over the last month. At the time we wrote “…helps emerging markets and would mean the Fed probably talks a dovish story in March” and that is exactly what Yellen did in her speech in late March with the essence of the message being they are willing to tolerate more than 2% inflation and taking thetotal hikes this year down to just one from here.
A more cynical view would be that this was indirect admission that to do 4 hikes this year with the USD where it was, would probably result in policy error, which of course the Fed doesn’t make.
Either way it gave markets in general the relief of less rate hikes and Emerging markets the benefit of less USD pressure (remembering that they largely fund their debt in USD)
Chart 2: DXY Dollar Index
4) Economic Surprise Index improve: Data through March definitely improved, with the most noticeable being the ISM surveys that had dipped below 50 (expansion/contraction level) in prior months and are often watched as lead indicators of a recession, improving to back over 50
Chart 3: Citi Surprise Index
So when one puts together the list of what we thought may need to happen if the market was to go higher, with so many occurring it shouldn’t be surprising the direction of the market, even if the magnitude was.
As a firm we had positioned for this view and largely participated, even if not fully as we had put in place some hedges that cost money if the market rallied through 2000 by the middle of the month. Pleasingly the view the contrarian view on Emerging markets paid off.
Where to next then?
Always an interesting question, but one that is particularly difficult now after this rally. Probably the best way to describe it comes from a Merrill Lynch Strategy piece from last week:
“Are we in December 1998 and this is your last chance to buy or are we in October 2007 and this is your last chance to sell?”
What they are getting at is that the aborted tightening of 1998 which saw the LTCM blow-up, saw the Fed keep policy loose into a continued US expansion that topped with the Tech bubble; or the more recent case of the “false rally” of late 2007 after the belief that sub-prime was famously contained and the Emerging Markets would “de-couple”.
It would seem the consensus amongst investors is that it is the latter – that selling here is your last chance to get out. Perhaps worryingly is how consensus this view is as evidenced by the BAML Fund Manager survey which shows funds still holding near record levels of cash.
Our current thinking is another option – that we are in a range for now of say +/- 5%. This sort of view doesn’t sell newspapers - the idea that markets are directionless - but for markets, it’s actually quite a common outcome to do nothing for a period of time.
For the bulls, the size of the move in such a short time suggests at the very least a period of consolidation. They are butting up against strong technical resistance levels; earnings season will largely reflect the prior strong USD (impacting earnings lower) and the lower YoY oil price; multiples are not particularly compelling; and buybacks by corporates are on hold over reporting season (these have been large net purchaser of equities)
For the bears, it’s a period of licking their wounds and acknowledging with the Fed out of play largely and improving US data with decent job growth their case is shakier than 2 months ago. High yield markets have seen spread compress a lot and issuance rise there and in investment grade, negating one of the bear cases from early this year.
The area of interest for us is emerging markets. 1 month EPS revision data has turned positive, though 3 months is still poor. With many funds underweight and some markets such as the Hang Seng trading at historically large Cyclical Adjusted P/E (CAPE) discount to the US it is a region to consider and with the Chinese RMB devaluation issue sidelined by the Fed.
Then as we head through the middle of the year, to watch the US wage data evolve and what that means for the Fed – who after all only 12 weeks ago suggested 4 hikes were in order!