By Michael Green of Icefarm Capital
And so it begins…
As postulated last week, we had entered the Wile E. Coyote moment where hovering risk assets had little underpinning. This proved to be largely correct, although obviously disappointing in the US versus the “Lehman” comparisons that circulated in the popular press. In contrast, European indices in US dollar terms absolutely cratered. To suggest that this has been the calmest risk-asset disaster in history doesn’t seem like an understatement. Since last year, the S&P 500 is down 1% (up on a total return basis) while:
The outperformance of the S&P500 versus the FTSE100 has been, in simple terms, unprecedented. In fact, we are approaching the sixth straight year in which the S&P 500 has never trailed the FTSE100 in USD terms:
And it’s not like it’s getting any better soon… annualized alpha for the FTSE vs SPX is bouncing on historical lows as well. In simple terms, UK stock markets have been an unmitigated disaster:
So it perhaps shouldn’t feel like a big surprise that Friday felt like the calmest end of the world trading day I have ever experienced – it was just Europe doing its thing. Perhaps that’s because I’m hanging out with a better sort of crowd these days, or perhaps it’s because we have become inured to the relevance of markets on our daily lives as US large cap equity markets have taken on a Teflon coating. However, I would note that the data strongly suggests that the relationships have changed. The classic critique of macroeconomics has been that the R-sq between GDP growth and risk assets has historically averaged around 13% -- not very high. However, that generalization misses a much broader sweep – since the late 1990s, markets have lost their “predictive” powers and become increasingly correlated with economic activity. Theoretically, picking the economy IS picking the market:
This in turn has been correlated with a disassociation of Fed policy from underlying economic activity:
The unlimited ability of CBs to “prop up” financial assets has been shattered around the globe as Kuroda and Draghi are unable to protect asset markets (Carney as well apparently), but in the US, faith in Yellen remains high. Perhaps I’m old fashioned, but I believe that this too shall pass.