All That for Nothing?

1250 words – a 4 minute read.

The title in question is what I asked myself after comparing last Thursday’s close (pre Friday selloff) to yesterday’s close and realizing ACWI was completely flat, 0.0% change. Was the market action just another opportunity to get chopped up or was there more to it? 

Please tell me there was more to it… ok, I will. While we have spent much of the past few months debating the onset of the Fed’s tapering program and thus discounting it I would argue that this week we did the same with the Delta variant. Given that these are two of the three main concerns as I see them and they set up the third, namely growth fears, this is an excellent outcome from a forward looking POV. Its also consistent with how this bull market has acted since last March – a master class of bubblet popping and discounting.

Arguably last weekend saw the interplay of several concerns set up by an equity market that seemed tired & overbought with overly bullish sentiment and a string of recent new highs (last Monday was a new ATH for the S&P). These concerns included peak growth worries, Delta’s rapid spread and its impact on growth and concern over policy mistakes either from an overly aggressive Fed or a legislative failure to advance the US infrastructure plans. Add in the OPEC + deal and you got Monday’s sharp and widespread selloff.

Monday’s selloff led to an oversold condition in the broad US equity market, the most oversold since the March 2020 Covid low, according to some market observers. CNN’s Fear & Greed monitor hit 17, extreme Fear & lowest since yes the March 2020 low, while BofA’s fund manager survey reported the gloomiest growth and profit outlook since last Nov. All this in turn set up the sharp bounce back on Tues – Wed, back to back up days for over 80% of S&P constituents, a first since, guess when, March 2020. Such breadth thrusts usually signal more gains ahead.

Amidst all this market action, climate change was brought home to people around the globe; NYC got its taste with a thick haze settling over the city Tuesday as smoke from the 80+ wildfires burning out West wafted across the country to the city, heralded by warnings of “unhealthy” air. Personal experience drives political engagement, political engagement ensures role of Big Govt.

This juxtaposition manifested itself in our model portfolios. In checking the models for this 5 day period I noticed how well the TPW 20 global thematic portfolio held up with only 4 of its 20 ETFs down over the period. This surprised me given that these thematics are considered high beta and as such would be expected to be more volatile in markets like this past week.

Our multi asset model performed in a similar fashion, with roughly equal number of ETFs up and down more than 1% for the period. Many of the Cyclical/Value instruments we own entered this period already approaching oversold conditions as the UST rally led to Growth stocks sharply OPing and Value selling off. This meant that much of the equity market and global markets had already been pretty well sold, cushioning the downside risk of a major selloff.

So where do we go from here?

The Delta variant is scary but its important to note some facts: over 60% of adults in the US and EU are fully vaccinated while China reports fewer than 20 cases last week. Thus, the majority of the global economy is pretty walled off from the variant. In addition, Bloomberg’s excellent Covid tracker notes shots are running at over 33Mpd globally with China giving 10M, Europe 3.5M, Japan 1.5M, Brazil 1.4M, Poland roughly 1M… etc. etc. The US by the way is down to roughly 500k pd. 

At this rate it will take roughly 8 months to vaccinate 75% of global population, ie end of Q1 2022. Notwithstanding the media firestorm, the collapse in cases in both India and Brazil suggest the upside of Delta is it moves through populations very quickly; the majority of new cases now come from DM, not EM.

I have highlighted for several months the main tactical issue: the Delta spread vs the vaccine production and vaccination surge. I continue to think that the vaccination surge will win out as we move thru the 2nd H and into 2022, that the Delta variant will accelerate the vaccine take-up and the 2H production of an estimated 6B doses in the US and EU will overwhelm the virus and set up the synchronized global economic expansion I have highlighted.

Growth is a market concern but today’s European preliminary July PMI report should help alleviate that concern with Service PMI coming in BTE and up vs June to the highest level of the recovery pushing up the Composite as well. Investors are struggling with the shift from peak growth (Q1 in China – Covid 1st in, 1st out, Q2 in the US) to a more normalized global recovery but I expect that struggle to ease as they take on board that US GDP is forecast to be 5% y/y in Q4 and 3.5% y/y in Q2 2022  – both well above pre Covid trend. JPM notes credit, which is usually the canary, is fine with zero fallen angels in Q2, leading it to cut its 2021 fallen angel estimate by 75%.

Policy risk remains an open issue but here too  good news is forthcoming as the legislative sausage making (never pretty) seems to be advancing on the bipartisan infrastructure plan – success here sets up the much larger track 2 with its passage likely via reconciliation. Fed risk is also a worry and I would be lying if I told you I fully comprehend what’s going on in the bond market but there is clearly no pressure for the Fed to be aggressive while the ECB made it plain this week that it will not raise rates until inflation is at 2% (its internal forecast pencils in 1.4% inflation in 2023).

Perhaps most importantly earnings are coming thru as expected – like gangbusters - across the globe according to JPM who notes that most importantly, those US companies providing FY updates are guiding higher at the highest percentage (well over 80%) since 2012. GS notes that US productivity has roughly doubled post Covid from 1.5% to 3% - good for above trend growth, company margins & earnings.

Thus the outlook remains: as we move through the 2H and into 2022, staggered reopenings give way to a synchronized global economic expansion as the vaccine production surge defeats the Delta variant spread, leading to continued strong GDP and EPS growth, higher rates and renewed upside for the Cyclical/Value segments and ex US DM markets together with Commodities and Climate, Cyber and Fintech related thematics. Laggards should become leaders; MS notes that Lat Am, a strong Q2 performer, still trades at a 25 yr, record wide, forward PE discount to broad EM.

I flesh all this out in this Ohmresearch “Live” video shot after Monday’s close so real time analysis…a full hour with Ohm’s Roberto Attuch who ensures we cover ALL the ground.

The Olympics open today – I expect some great competition, audience or no audience; Fed meets next week, US buybacks restart and 44% of the S&P reports earnings – rest up!

TGIF – I am off to the woods of Western Mass for some fresh air!