Sluggish Weekly Start for the Risk-On Trade

It’s a rare rough start to the week for the risk-on crowd

Highlights

• “One-in-ten” stock market means it’s time to focus on risk

• Beware of the “front cover” effect

• Less to the employment data than meets the eye

• Gold does not get old

While We Were Sleeping

It’s a rare rough start to the week for the risk-on crowd. U.S. futures are in the red, although in recent times this has served as a contrary indicator for the entire session. The Euro Stoxx 50 index is off -0.6% at the moment and the U.K.’s FTSE 100 has dipped -0.4%. Outside of extended recoveries in beaten-down Hong Kong (+1.4%) and China’s Shanghai Composite (+0.7%), Asia closed in the minus column, ending a four-day winning streak (and the worst showing in two months): Japan’s Nikkei 225 (-2.2%; the worst session in five months with the large-cap exporters taking it on the chin — as BoJ tightening views escalate — 31 of the 33 TOPIX subsectors declined today), Korea (-0.8%), India (-0.5%), Thailand (-0.4%) and Taiwan (-0.3%). Australia brought up the rear, slumping -1.8% in the worst showing for the S&P/ASX 200 benchmark in a year.

The DXY dollar index is stuck at 102.7 as the dollar licks its wounds after the drubbing it has taken since mid-February. Bonds have a small bid overall, with the 10-year T-note yield trading down -2 basis points to 4.06% — nobody seems too fussed about the elevated inflation readings the consensus has penned in for tomorrow’s U.S. CPI data for February (+0.4% MoM for the headline and +0.3% on the core). Futures are pricing in 100% odds of a Fed rate cut in June and are back pricing in four moves by year-end.

The odd man out today was the 10-year JGB, where the yield popped +2.5 basis points to 0.75%. Not only is the current round of wage negotiations in Japan squarely on the BoJ’s mind (looks to be the most aggressive labor demands in three decades, at +5.85%), but the country ended up not moving back into a technical recession, after all, as Q4 real GDP growth was re-estimated at +0.4% QoQ annualized instead of the initially reported -0.4% contraction — the biggest contributor being business capex. All market quotes are time-stamped to 4:15 a.m. EST.

The yen is hovering just below ¥147 per dollar, extending last week’s +2% gain and the hugely undervalued currency looks like a coiled spring. Bitcoin is up +2.5% to $71,212, but WTI is off -0.2% to $77.85 per barrel (after sliding -2.5% last week), while spot gold is holding onto its record-high at just below $2,200 per ounce after last week’s near +5% surge and performing magnificently well in virtually every major currency. Iron ore has been crushed a further -5% overnight as investors look past the Chinese inflation hiccup as a seasonal aberration (all of the CPI pick-up was in prices related to early-year tourism effects) and focused on signs from the high-frequency data that underlying domestic demand remains pressured to the downside.

I chuckle when I hear how the unemployment rate, the lagging of all lagging economic indicators has now been south of 4% for twenty-five months in a row — and how the last time that happened was in the late 1960s. From January 1968 to January 1970, to be precise. Guess what? The recession began in the 24th month — December 1969! Only after having risen a half-point from the cycle low — as has been the case this time around. Was everyone in the “soft landing” camp back then too? As an aside, the last three recessions started with the unemployment rate “low” at around 4% — it is never about the level, it is always about the change when we are talking about this metric and its impact on “growth.”

As for the stock market, I keep getting asked about what I “missed.” Well, what I “missed” was a 1-in-10 event whereby the S&P 500 rips nearly +30% over a year in which earnings only rose +4%. A 1-in-10 event in the forward P/E multiple expanding 3 full points to 21x, a level it has only achieved 10% of the time in the past. All the while, consensus views on 2024 EPS estimates haven’t budged — but what is interesting is that analysts collectively see +11% earnings growth this year (and a further +15% for 2025) even though the Fed’s own cheery forecast is for +3.8% nominal GDP growth this year. Let’s see — last year’s +6% nominal growth could only muster a +4% earnings trend, but for this year, an expected economic performance of about half that is supposed to generate profit growth triple of what we experienced in 2023. Look ma — new math!

If I was skeptical a year ago, I remain even more so at the moment. I don’t tend to chase manias and I never chase bubbles. Just because it isn’t as extreme as 1999-2000, we are in a market bubble, and valuations are even more stretched today than they were at the market peak in October 2007. A 4.8% equity earnings yield versus a 5.4% T-bill yield is not the most alluring comparison I have seen in my investing life and I suggest that we all should be looking at risk-adjusted returns as opposed to the illusion of gross returns with no view towards the prospects of drawdowns and capital erosion, which tend to be elevated when multiples approach these sort of top-decile levels.

As I said in my letter last week, momentum-driven markets can be very powerful beasts over the near term, but fundamentals always win out and the starting point for the multiple always and everywhere acts as either a long-term tailwind when they are in the bottom 10% (1982, 1991, 2003, and 2009) or a headwind when they are in the top 10%, as is the case today.

Beware of the “Front Cover” Effect

A week after The Economist ran with this…

… Barron’s decided to go with this (right below). Beware of the “Front Cover” effect — when news like this makes it to the first page, it’s all in the price.

Time will tell if Friday’s impressive negative reversal will be a tell-tale sign or not. Is this a market suffering from buying exhaustion (the S&P 500 hitting no fewer than 16 new highs since November 1st and now trading some 12% above its 200-day moving average). Or is the FOMO mentality simply too strong? Nonetheless, even as I had one of my most vocal bullish clients email me around 2:00 p.m. to await a late afternoon market recovery, that never did happen. The intra-day reversal proved to be spectacular, with the S&P 500 down -65 points (-1.3%) from the intra-day high to the close (-2.2% for the Nasdaq). Not only that, but volumes on both the NYSE and Nasdaq rose as the selling intensified. Let’s see if some rationality settles into a market where the forward P/E multiple, at 21x, is more than 30% above the long-run norm.