We Are Focused on Changes Rather Than Levels

The current and unprecedented macro shock prompted a marked deterioration in both market sentiment and growth asset valuations. However, we are now seeing increasing signs of a stabilisation across each of these three dimensions. Macro data remains grim but it has stopped getting worse, especially the highest frequency data. Market sentiment is still bearish but positioning has settled, opening the door to a more rational price evolution. Finally, valuations have partially retraced from very low territory. All factors that determine our dynamic asset allocation have therefore stabilised: we think that the time has come to focus more on the direction than on the level of things. Our dynamic positioning retains its neutral stance but we have positioned tactically to profit from selected credit spreads and equities.

What’s Next?

The second derivative shows early signs of stabilisation

Macro indicators have collapsed globally, reflecting the rapid implementation of lockdowns and economic inactivity throughout the world. Market observers have witnessed variations in macro series unlike anything ever seen before. The most emblematic of these extraordinary variations is probably the increase in US jobless claims, which rose from an average of 200,000+ per week to a peak in 27 March, reflecting an increase of 6.9m job losses. As of last Friday, the US unemployment rate reached 14.7%: a total of 20m people without jobs, albeit temporarily for some of them. This deterioration in macro series rapidly led our Growth Nowcasters to reflect the fact that the world was facing a global, lockdown-triggered recession. In the case of the US, it has reached -2.3 standard deviations, with the Eurozone and the UK showing similar levels, while China, Thailand and South Korea remain in the -1 to -1.5 region. Nobody can dispute the message conveyed by these values: the shock we are currently experiencing is extremely bad.

A key element in our understanding of the connection between macro and market dimensions is that when the macro side ceases to deteriorate, this is usually the moment to, at least, neutralise a negative bias for growth assets: to some extent, the derivative matters more than the level of macro conditions.

A recovery should be coming as the lockdowns end, but it will take time to show in genuine macro data. To capture this stabilisation, we are looking in three different directions:

• First, we have created our “Newscaster” indicator that assesses prevailing opinions about economic growth as expressed in the media. Over the past four weeks, this indicator has shown signs of stabilisation. Currently, 49% of this data is improving, meaning that the deterioration has stopped in the eyes of the media.
• Second, we look at whether macro data releases surprise economists to the upside or downside. Entering into the deterioration period, economists are usually surprised to the downside. As this deterioration begins to slow, surprises tend to be more balanced, as was the case at the end of the past four macro shock periods (2001, 2008, 2011 and 2015). Across the G10 surprise indices, 45% are currently improving. Here again, a sign of stabilisation emerges as this number was 38% two weeks ago.
• Finally, freight data, which is of a higher frequency than standard macro data, is worth considering. Railway freight in the US provides an abundant source of macro information on the strength of US domestic demand. Here, more muted signs of stabilisation can be found. Over the past two weeks, the percentage of improving data moved from 34% to 38%.

Our Growth Nowcasters currently show that 30% of data is improving: this number will eventually confirm what we see elsewhere. For now, this early stabilisation is reflected in our strategies through an overweight for “quality growth” equities such as the Nasdaq and the SMI: this positioning aims to profit from this early macro stabilisation.

Monetary policy has not yet fully kicked in

This stabilisation comes with a boost from central banks and governments. In our opinion, this is now old news but it should keep on influencing markets, especially investment grade credit.

The key liquidity and corporate bond buying programmes of the Fed and of the ECB have been announced, with most of them partially implemented around the end of March / beginning of April. What strikes us about this is what is happening in credit markets: the Fed has not yet started buying bonds and is currently readying itself for ETF purchases. Yet, cash bonds have seen their spreads contract rapidly. In the US, investment grade cash bond option-adjusted spreads over government bonds reached a peak of 401 bps on the 23 March. Since then, they have come down very rapidly and stabilised at around 225 bps. In investment grade European credit, the peak was reached on the 24 March at 243 bps, but currently sits at 187 bps. In our valuation metrics, in spite of this tightening in spreads, the investment grade spread risk premia does not look expensive yet. Historical analysis suggests that the 12-month forward return following such a level has been positive with a 70%+ hit ratio. Finally, as the Fed starts buying bonds without price sensitivity, its mechanical impact will further narrow these spreads. We see here a remarkable alignment of planets, from valuation to demand in the investment grade space. Once the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) actually start providing liquidity to corporate bonds markets, we should see a second wave of spread compression. Here again, regardless of the level of these interventions, what matters is the direction of travel for spreads: tighter.

Sentiment as a tailwind while valuation neutralises

Finally, the last elements showing signs of bottoming are market sentiment and valuation. First, most investors have decreased their equity exposures, according to survey data. The AAII US Investor Sentiment survey shows that 50% of respondents are currently bearish, which is actually very close to the average across the month of April (47%). The different beta measures we are looking at show a stabilisation in the equity positioning across many types of investors – quant and discretionary. As many retail investors are still holding a large portion of cash, this should instill in markets a “buy-the-dip” kind of psychology that could also support growth-oriented assets in the future. What is more, investor positioning is now much cleaner than before the crisis: should markets go through another round of downward correction, this should help cushion the extent of the drop, which is noteworthy now that geopolitical tensions could be building again. Finally, the valuation of growth assets through our indicators are showing a consistent pattern: they moved from expensive (January-February 2020) to cheap territories (March-April), but they have stopped getting more attractive.

Our conclusions regarding the developments in these three factors (macro/sentiment/valuation) are the following: the situation is bad globally, but we think the time has come to focus on the direction of these early trends. This is why we have moved our positioning from defensive to neutral. This neutral stance is currently becoming more positive through overweights to investment grade spreads, “quality growth” equities and emerging equities in ways that best reflect our current assessment.

Unigestion Nowcasting