In his latest Global Equity Strategy update piece, Credit Suisse strategist Andrew Garthwaite takes a random walk across Wall Street's trading desks, and confirms what many know: namely, that nobody actually knows anything.
Garthwaite writes that "his team has come across almost no one who seems to have outperformed or made decent returns this year." He cites data from Morningstar according to which in the year to July 1st, just 29 out of 242 funds in the Investment Association UK All Companies sector beat the performance of the FTSE All Share. Moreover, the Dow Jones Credit Suisse Long/Short equity index, which tracks hedge fund performance, fell by 5% year-to-date.
As a result, the reaction by active managers to outperform the broader market, or even their benchmark, in a time of surging redemptions, has led to what may be best described as performance paralysis, or better yet panic:
"we have never had so many client meetings starting with statements such as 'we are totally lost'."
What makes things worse, is that even as central banks push stocks to record highs and beyond, the "fundamental analyst" in every investor is screaming that prices are just too damn high. As Credit Suisse puts it, "clients are close to being as bearish on equities as we can remember. Clients do not find equity valuations attractive enough to compensate for the macro, political, earnings and business model risks."
And yet, the Fed keeps forcing every investor starved for yield, into risky assets, which are now trading at multiples exorbitant that even Goldman has repeatedly warned, most recently this weekend, will lead to a very unfortunate outcome.
Why are traders so gloomy?
"Clients do not find equity valuations attractive enough to compensate for the macro, political, earnings and business model risks." They also see "structural disinflation, China and a US economy that is late cycle causing US yields to fall further." Specifically, clients cite worries about the lack of rebalancing in China and ongoing weakness of the RMB; they are concerned about the lack of policy weapons if there is a shock to growth (into a recession, real rates have fallen by c.5%, on average) requiring, of course, fiscal QE.
In what is emerging rapidly as the biggest stumbling block to investor optimism everywhere, clients cite abnormally high political risk reflecting itself in increased protectionism, a desire to reduce immigration, and a boost to minimum wages to rebalance the economic rewards towards labor and away from corporates;
Finally, clients cite significant business model risk as a major risk factor. "Some clients thought that the single biggest risk was disruptive technology shortening asset lives, creating price visibility, lowering barriers to entry and driving down demand (via the sharing economy). In addition, corporates are facing a growing competitive threat from China exporting its excess capacity on the wrong cost of capital (SOEs have an RoE of 3% but account for 55% of investment, against just 22% of GDP)."
In retrospect one can see why with so many concerns, over and above merely underperformance worries, most investors "are totally lost."
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More details from the report breaking down how investors view various asset classes.
In general, CS found that their clients were as bearish on equities as they could remember with clients concerned that equity valuations were not attractive enough to compensate for the macro, political, earnings and business model risks. We think that clients are too pessimistic. The ERP is marginally cheap (on our model) while bonds, credit and real estate look abnormally expensive. Liquidity and positioning are also supportive of equities.
- US corporate earnings appear to have peaked, with labour increasingly gaining bargaining power (relative to nominal GDP of just 3.3%);
- Equities are not cheap in absolute terms. The trailing P/E ratio of the S&P 500 is c.28% above its 50-year average, while the Shiller P/E is about 33% above its 50 year average;
- Some mixed readings on US growth (with a number of clients citing the Fed's change in labour market conditions index having fallen to its most negative since 2009, although admittedly in the last month it has turned up);
- The lack of rebalancing in China and ongoing weakness of the RMB (which is down c.2.6% YTD versus the USD);
- The lack of policy weapons left if there is a shock to growth (into a recession, real rates have fallen by c.5%, on average) requiring, of course, fiscal QE;
- Abnormally high political risk reflecting itself in increased protectionism, a desire to reduce immigration, and a boost to minimum wages to rebalance the economic rewards towards labour and away from corporates;
Clients are warming up to emerging markets. This is a region we have been overweight since December. The key driver is high real bond yields in local currency terms, while currencies (ex the RMB) are still very cheap. We would highlight indirect plays such as SGS, Vodafone, Endesa.
Bonds: 'lower for longer' is becoming 'lower for ever''
Clients see 'lower for longer' now being 'lower forever'. Net speculative positions on Treasury futures are now close to a 3 year high. Clients see structural disinflation, China and a US economy that is late cycle causing US yields to fall further. We see signs of a rebound in lead indicators, core inflation stabilising (with signs of US wage growth accelerating) and, above all, a move away from NIRP to looser fiscal policy placing upward pressure on yields. Consumer staples are now 2 standard deviations expensive.
In Europe, CS clients are capitulating. "Many US clients believed Brexit meant the end of the euro (with Italian constitutional referendum being the next key event). Outflows are close to record highs, valuations are back to Greek crisis lows on P/E relatives yet earnings and economic momentum are showing signs of relative stability. Focus on European domestic demand plays."
Oil: upside risk. CS clients see a risk of a spike in the oil price to $60-70pb despite the 3 year forward being $56pb. The Swoss bank however, sees oil as capped closer to $50. For now, however, the real pain has reemerged, and it is not higher.
Japan – close to record foreign selling. This is despite valuations (relative to the US) being back to pre-Abe levels and clear corporate change (with buybacks up very strongly). Credit Suisse contends that policy has to become more stimulative. We will get the answer tonight.
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Finally, and curiously, Credit Suisse said that China is "largely off the radar screen." It adds that this is unwise when housing lead indicators have peaked and state investment growth is already at a 6 year high. We agree, and since China has merely papered over its problems stemming from record debt levels with even more debt, it is only a matter of time, before China returns to its rightful place, front and center of the "radar screen."