Having turned over the past few months from reflationist, to increasingly skeptical of the whole reflation impulse scenario - mostly on the back of China's infamous credit impulse crashing - RBC's Charlie McElligott takes a look at the three "negative narratives" that are gradually emerging for the markets. But before listing them, here is his latest summary of where the increasingly more confused market finds itself:
From "The Battle Of Who Could Care Less" by Charlie McElligott
- My ‘macro range-trade’ thesis continues to be representative of the lowest-conviction market I’ve seen in a long-time, with ‘risk-sizing’ at VERY muted levels.
- Sentiment “paper-cuts” are mounting with risky-assets sitting near recent nose-bleed highs, making them ripe for today’s modest draw-down into poor liquidity.
- Negative client narratives are building largely around this idea that 1) the Fed is tightening (staying ‘on message’ with hawkishness); 2) China is deleveraging (PBoC has ‘room to run’ in light of recent + data overshoot); 3) the ECB is pivoting ‘less dovish’--all while 4) the global economy is mean-reverting ‘slower’ following the outstanding expansion since last Summer.
- Today’s Macy’s earnings clunker dragging down ‘bricks-and-mortar’ retail / REITS and adding to the laundry-list of consumer- / credit- stories weighing on the psyche (weak SAAR prints, US subprime auto concerns, CA subprime housing, US credit card delinquencies), as we not-so-ironically print six-week lows in today’s US Consumer Comfort Index.
- Despite WTI Crude’s +6% move off the Tuesday lows, hawkish Fed language, generally ‘better’ US data this morning and a HOT-GARBAGE UST 10Y auction yesterday, nominals remain unable to cleanly-break
- 2.40 / 2.45 level as domestic buyers offset fast $$$ sellers who’ve been keen to reset shorts.
- Risk-asset ‘bull case’ still formidable too though, namely (still) expansive PMIs and the best first quarter earnings season in five years—with buyside expectations of ‘fiscal policy’ kickers (taxes, infra) coming late ’17 / 1Q18.
- As such, 2.15 / .20 in nominal US rates has proven to be the level where you ‘buy reflation’ (long banks-cyclicals-‘value’ equities / long ED$ steepeners or TY shorts); ‘sell reflation’ at 2.40 / .45.
- This is then notable today, as despite UST curves being modestly steeper for the first time in awhile / nominal yields at upper-end of recent range, we continue to see US financials act poorly now -1.5% WTD with generalist selling any uptick.
- US equity ‘value vs growth’ ratio collapsing back to 2015 lows, as last year’s ‘reflation / fiscal stim’ bounce is completely unwound.
- Investor preference for ‘secular growers’ with negligible policy- / interest rate- sensitivity relative to last year’s ‘cyclical beta’ high-flyers shows lack of belief in long-term economic growth / higher rate profile, and largely mirrors the recent relentless flattening of UST curves alongisde the sizeable outperformance of ‘quality’ factor market-neutral over ‘size’ m/n of late.
With that in mind, here is RBC's head of cross-asset stratgy allowing his readers to "pick their poison" from the following meny of negative narratives that are increasingly replacing the bullish outlook:
- “The global economy is slowing into a tightening regime,” based-upon the recent global data mean-reversion into Fed / PBoC ‘hawkishness’ and ECB ‘less dovish-ness.’ This is another expression of the “central bank policy-error” theme.
- “We’re tightening into a disinflationary impulse,” based-upon the Chinese deleveraging-effort impacts on global commodities / ‘inflation expectations.
- And now after today’s PPI- and Jobless Claims- (“tight labor market”) data, revisiting an ‘oldie but goodie’—“Stagflation” fears again being noted by clients.
REGARDING THE ‘STAGFLATION’ ANGLE ABOVE—NICE INFLATION TAILWINDS TODAY:
5Y breakevens are widening back to 1.83 for the first time in a week on a triple-whammy of:
- the crude bounce (five consecutive crude draws in conjunction with OPEC members strategically engineering the short-squeeze with headline commitments to production cut extensions / enhancements just as net positioning went to LOTY last week per CFTC data),
- further lows in US Jobless Claims and most obviously
- a big PPI beat, which portends +++ for tomorrow’s CPI print.
THE FED KILLED EQUITIES ‘VALUE’:
I spent the majority of last year discussing the drivers of the pivot from ‘deflation to reflation’ and the impact that had on every global macro thematic trade in the world: ‘long vs short duration,’ ‘cyclicals vs defensives,’ ‘EM vs DM,’ ‘high vs low beta’ and of course, ‘value vs growth.’
It’s now become utterly clear to me that easing financial conditions / suppression of rate volatility is what has ‘killed’ equity ‘value’ factor (especially as it relates to ‘growth’). Look at the relationship below seen between the ‘value / growth’ ratio and the Fed’s “lower / flatter forever” policy. Last year’s ‘reflation’- / ‘fiscal policy’ –induced interest rate volatility higher provided a period of massive ‘value’ over ‘growth’ outperformance.
Now, ‘value’ is again massively underperforming ‘growth.’ After late last year's 'value' run (think cyclically geared stuff), the ratio vs ‘growth’ (seculars like tech, cons disc, biotech) is back again collapsing. There is just so much market skepticism regarding the long term growth outlook, which also happens to mirror the relentless flattening story in UST curves YTD, or the sizeable outperformance of ‘quality’ factor market neutral vs ‘size’ factor m/n.
Ironically, it should be noted that today there is speculation of a large ($1B) equities program being executed away, rotating INTO VALUE and out the past year’s ‘momentum’ high-flyers like financials, tech and consumer.