Global Equity Markets continued to squeeze higher in August, particularly in Tech space as momentum and quality strategies continued to run heavily while Value continued to take a hit – albeit bouncing towards the end of the month.* The Dollar remained under pressure, with the Fed announcement at Jackson Hole that it wasn’t going to so explicitly target inflation being used as justification for selling the currency, although in truth as we head to the November Election both the Dollar and the US bond market may be telling another, different, story; international investors are moving to the sidelines and the US market is increasingly being driven by short term stock traders in the tech space.
Update. Shortly after we went to ‘press’. we discovered that many of the strange phenomenon we discuss appear connected with SoftBank buying enormous amounts of options in narrative tech stocks. The unwind of this will likely be a key story for September. See here
The S&P is expensive and overbought and the Vix is the highest it has ever been at an all time high, which should give us pause for reflection. Meanwhile our market risk indicators are ticking up. September has a bad reputation for market behaviour and October also tends to be weak in an Election year. As asset allocators return from wherever they have been locked down this summer they are likely to be locking in some protection – certainly the Vix is rising – in anticipation of a bumpy ride for the rest of the year.
* Note that the first few days of September have seen a lot of this froth given back, particularly in some of the narrative areas of tech.
Short Term Uncertainties
The US Presidential Election is now within the three month time horizon that drives uncertainty for markets and is currently split between two major topics; Covid and Civil Unrest. Over the summer, Democrat strategists were relying on President Trump’s poor handling of the crisis and the resultant economic downturn to combine to give them a landslide victory and thus they effectively followed a do nothing, say nothing strategy, with Wall Street buying into the notion that they were all but guaranteed to win. Given that Biden is heavily tied to the Finance Industry and running mate Kamala Harris to Silicon Valley, the fact that the rest of Fortune 500 America has swung behind them – as indeed they did for Hilary – means that they effectively are now the Global Capital Candidates. As such Global Capital will exaggerate the ultimate result in the same way they did with both Brexit and Trump last time around. This is not to say that we should definitely be contrarian, just that Global Capital can get as politically emotional as anyone else.
As we look into the ‘Fall’ however, that certainty is evaporating a little. The Covid response is actually largely at the state level and the fact is that Blue, Democrat led, states are faring far worse than Red, Republican, ones. This is not to say it is necessarily local government’s fault, rather that it is difficult to blame central government when you have been resolutely ignoring their advice.
Chart 1: Covid hitting Blue States much harder.
The same of course goes for the Civil unrest, which is continuing and, once again, seems to be far worse in Blue states and, even worse for the Electoral calculus, particularly in the so called ‘battleground states’ (sic). The fact that the Democratic leadership have been very slow and hesitant in criticising the burning and looting is driving many into the Republican camp, however reluctantly. Consistent with the whole tone of this, awful, year, fear is dominating greed and Law and Order issues are increasingly going to dominate discourse.
The result is that both Trump and the prospect of the Republicans in the Senate are showing clear increases in the polls and, to steal an old title from an earlier note, there is a risk of the Pandemic producing a Dem Panic. In response to this increased uncertainty, the traders continue to sell the Dollar, which as we discussed last month was the largely hidden underlying market story of August. This month it is much more obvious. We would also repeat our observation that a weak dollar may actually be seen as a desirable policy outcome for many in the US and that this is something bottom up analysts need to be examining from a cost and a competitiveness aspect.
The other important variable that is moving is the Vix, the implied Volatility Index that can basically be thought of as the price of put options on the S&P 500. This has moved up quite sharply since the beginning of the month. We are grateful to our good friends at Redburn Partners for highlighting the differing behaviours of the generic Vix indices for the four forward months, September through December, with the point made that the October Vix (UX2 on the chart) is, unusually, running higher than either November or December let alone September – suggesting an obvious Election hedge.
Chart 2: Vix is rising ahead of increased Election Uncertainty
We should also bear in mind that most of the impetus in the US markets in recent months appears to have come from the RobinHood day traders (reminiscent of the Chinese day traders back in 2015) for whom the traditional metrics don’t seem to matter – until they do. Thus we have seen the Nasdaq move higher on around three quarters of the days over the last three months. We have seen Apple trade at a market cap greater than the whole of the FTSE100, or the combined weight of the US financial and Oil and Gas industry if you prefer a domestic metric. We have seen Zoom spike 50% in a day and Tesla do a stock split and continue higher, regardless of the lack of profitability and the competitive edge being eroded.
To be clear, we are huge fans of the Tesla product, indeed spent much of the summer driving one around Europe avoiding the assorted lockdowns and quarantines, but while the model S is a perfect Grand Tourer, the rest of the range is so-so and the competition is coming. Fast. When it is all (only) about momentum and telling the story, fundamentals don’t matter. Until they do. One profit warning or a capital raise and it could get very messy. This is not a stock call, rather an observation that the apparent ‘health’ of the US stock market is likely telling us more about the fact that individuals are re-rating it in the same way institutions re-rated bond markets over the last decade. But if they are in the driving seat on Tesla (sic) we need to try and understand their strategies. If it is all momentum, then that is where we need to focus. The same is true of our old friend Zoom, which jumped 50% at the end of August, before dropping back. It certainly had great numbers, but few institutional investors could see why they justified a multiple (on upgrades) of 200x . It would be interesting to find out if Li Ka Shing, whose stake in the company was valued in excess of $11bn on that spike was a seller at that peak.
Meanwhile, the fact (also from our friends at Redburn) that almost three quarters of single stock options are currently in the high risk, ultra short term region of under two weeks is also indicative of a polarity between cautious institutional investors and enthusiastic amateurs and suggests a likely pick up in realised as well as implied volatility in the coming weeks.
Medium Term Risks
With the US Election now in the short term uncertainty box, medium term risks move out to 2021. From a monetary policy perspective, with the Fed continuing in its role as buyer of last resort we see the risk of an unpleasant liquidity event reduced, but further distortions likely in corporate bond markets as they split into those with access to ultra cheap capital and those with almost no ability to restructure their balance sheets. The reality of a V, L, U or even W shaped economy depends both on where within the economy you sit and the ongoing behaviour of governments. Autumn and winter will definitely make a difference. People happy to queue to get into shops in spring and summer sunshine will be reluctant to do so on a wet Wednesday in November. As such we suspect an easing of both rhetoric and enforcement, while markets periodically get enthusiastic about a vaccine. The normal Flu season will undoubtedly cause problems with ‘symptoms’, but ironically may normalise things a little. Already, summer flu is killing way more people than Covid, but if and when winter flu kills a meaningful number – as it always does – then perhaps, finally, a sense of perspective may be restored and the Covid panic may die out -albeit long after the actual virus has.
Meanwhile as asset allocators flatten positions, momentum seems to be running out of momentum – at least a little, with some rotation into value. This may well simply be a seasonal effect, with some market ‘muscle memory’ from this time a year ago, as shown in the chart comparing the I Shares Global Factor ETFs for Value and Momentum.
Chart 3. Momentum losing Momentum, Value showing some gains
The other likely aspect is that as per the Vix graph, traders are taking profits and asset allocators are moving to a more neutral position. Our own model portfolio for global factors – which includes these two ETFs as well as ones for Quality, Size and Minimum Volatility – has been rotating towards value in the last three weeks based on our risk metrics, having been holding a low exposure most of the year.
Risks and Model Portfolios
The main changes on the risk scores at the country level during August were in Asia, with both Asia Pac and Asia Pac ex Japan dropping to level 1, (attractive) joining the US and China. Meanwhile Japan dropped from 5 to 3. In terms of valuation, Asia Pac is now at 5 year highs, as effectively is the US.
At the US sector level, consumer staples joined consumer discretionary in the low risk basket, as did materials, while utilities went in the other direction. Technology is not surprisingly at 5 year valuation highs, dominating the overall market rating as well. In European sectors, risk level remains generally elevated, with a trade off between consumer discretionary (improving) and consumer staples (deteriorating). In line with global moves, tech and now materials are looking stronger.
In terms of Global Equity factors, value, the highest risk scoring factor has improved at the end of August, as has size (small cap), while in bonds, the yield curve continues to steepen at the long end, raising the risks in long bonds, leaving TIPs looking the most attractive.
The Global Equity Model portfolio posted a significant gain over the month of +5.93% but nevertheless under-performed the MSCI World Index, which gained 6.68%. Year to date however, at over 10%, the model portfolio is running at approximately twice the return of the MSCI world, with just over half the volatility. Top contributing factor in August was Quality, which gained +7.48% while the bottom contributor was Value, which contributed a mere(!) +2.34%. The factor ETFs we use are trading relatively steady in terms of risk, and few active trades were needed for the holdings, during the month except buying back some Value ETFs in early August after it rebounded from the dip, a factor in the reduction in risk. During the month, Momentum and Quality, the top two holdings, kept advancing while remaining in the lowest risk trading zone while Min-vol and Size also posted decent gains. It is likely that these two factors will continue moving away from the medium risk zone in early September towards low risk. The laggard factor, Value, it is still hovering around the medium zone. As of the end of August, the Core Global Equity Portfolio targets to hold more Momentum, Quality and Size ETFs, at around 25% each, with around 12.5% in each of Minimum Volatility and Value.
For the Global Bond Model Portfolio, the component bond ETFs are now showing a moderate downtrend, with 3 components recording negative numbers over the month. At the beginning of August, all the bonds except High Yield were trading at the low risk zone, however, most components indicated a step-by-step increase in risk. As of the end of August, Long Bonds, Corporate Bonds and High Yield have come down to medium risk, with TIPS now being the Bond ETFs lowest risk in the portfolio. Meanwhile Global Aggregate is standing at medium-low risk.
The Global Bond Model Portfolio posted a small loss over the month of -0.87% and under-performed the Bloomberg Barclays Global-Aggregate Index, which is also saw a loss, of -0.15%. The best performing bond ETF was TIPS, which gained 1.01% while the US Long Bond was the bottom performer, falling -4.57%. Year to date, the bond portfolio has returned 10.8% versus 6.1% for the benchmark, largely reflecting the higher volatility risk assumed earlier in the year post the Fed intervention at the end of March.
Consistent with the underlying Bond and Equity portfolios, the balanced portfolio posted a healthy gain over the month of +3.88% but under-performed the benchmark (70% MSCI World Total Return Index + 30% Bloomberg Barclays Global-Aggregate Total Return Index), which gained 4.65%. However, year to date, the performance is well ahead at 10.5% versus 6.8%, with a little over half the volatility. The top contributor was Quality (+7.48%) for equities, and TIPS (+1.01%) for bonds; while thebottom contributor was Value (+2.34%) for equities, and US Long Bond (-4.57%) for Bonds.
The Thematic portfolio posted another solid gain over the month of +5.91% and while it under-performed the MSCI World Index, which gained +6.68%, year to date the portfolio is up 23.3% versus the MSCI world at +5.8%. Moreover, it has achieved this with ‘normal’ volatility of around 13% compared to the abnormal levels of over 33% ytd for Global Equities. The top Contributing theme was Global Clean Energy, which gained +19.01%, while the bottom performer was Digital Security, which also posted a gain, albeit modest, of +1.72%. Having risen over 35% since April, the theme is clearly running out of steam a little.
During August, the thematic ETFs were trading at the lowest risk zone and posted decent gains. The portfolio had an equal-weighted holding at the beginning of the month and captured gains in each theme during the month. Gold however, is showing some slight retracement after hitting the historical high, while the rally in Healthcare Innovation ETFs has slowed down when compared to other themes. And these two components are expected to show more noises in signals, more scrutiny will be placed before executing trade decisions. As at the end of August, the Core Thematic Growth Portfolio targets to hold slightly less, in Gold and Healthcare Innovation and around 15% in each of the remaining themes.
