Stick To The Process

1912 words - a 5 minute beach read.

Its been quite the market whirlwind of late and when in a whirlwind it makes a lot of sense to sit tight and stick to one’s process. That’s our central takeaway from the past few weeks of global cross asset flip flops. This is especially the case given that last week had the smallest S&P weekly drop in over 6 years & this week the S&P regained all the ground lost and sits roughly 2% away from new all time highs! In football (coming soon yea!) it’s the standard; in global macro investing, it’s the process.

The other central lesson comes from a great Bloomberg article titled Quants Are Poised to Release A Wave of Cash In the Stock Market https://www.bloomberg.com/news/articles/2024-08-15/quant-funds-are-poised-to-unleash-a-wave-of-cash-in-stock-market?sref=ftskAWJe where it states how systematic, CTA, Vol control and risk parity funds are ready to put money back to work after the fastest deleveraging since Spring 2020. Its almost funny to see the speed of the flip flop and reminds us that markets are in fact moving much faster than even a few years ago as quants control more and more of the day to day trading. 

“We think that this time around the normalization process can be faster, it’s a matter of weeks rather than months,” Anshul Gupta, head of European Derivatives and Global QIS.  To us this just reinforces the need to ride through these vol storms rather than try and trade them.

The article notes the size of the potential flows of quant cash but what struck us was this comment at the end of the piece:  “Longer horizon buying flows are huge,” said Charlie McElligott, a cross-asset strategist at Nomura. We noted something similar in the Monthly – just how much cash there is on the sidelines around the globe; another support for our global macro blue sky outlook for the 2023-2027 period.

As noted, the speed of the market action continues to rachet up with the past two weeks setting records right, left and center. The VIX for example, which spiked above 65 just a week or so ago, just had its fastest decline on record &  is already back to 15 as I write, much as we discussed in last week’s Monthly. 

It seems increasingly clear that the volatility spike was as we have suggested, a market based, systematic fund led, risk off and not a market effort to price in recession. As we have noted previously, it is critical to have a process in global macro – a lesson that was driven home once again over the past few weeks. Here at TPW Advisory we calmly carried on with our long held process and did not attempt to trade or make big AA decisions in the midst of the vol storm.

Our view remains that unless one is an elite trader it doesn’t make sense to try and trade around these vol spikes which we expect to continue to pop up given the dominant position in the day to day markets of systematic trading shops. We view these episodes as healthy corrections – corrections that clear out the weak hands, wipe off the sentiment fluff and rebalance markets such that the next up leg can move forward on a solid foundation. 

The data points coming out just reinforce how fast and aggressive the one sided moves have been – here is just a small sample: On August 2 the declining volume was the biggest in the history of the NYSE (4.29 Billion). This means that was a capitulation day; hedge funds reduce their yen shorts at 5th fastest pace in history last week; we have hit one of the most extreme oversold conditions in history; hedge funds have their biggest commodity short in 13 years (we like this one). 

Here are two more: Data from Deutsche Bank show investors' aggregate allocation to stocks is now in the 31st percentile and underweight ... 3 weeks ago, exposure was at the top of the historical range in the 97th percentile. All Star Charts:  We just saw the largest week over week spike in bears among individual investors since 2022, just as this bull market was getting started. We just saw the largest decrease in II bulls since Covid, which was over 4 years ago. The last time newsletter writers got this bearish this fast, we went on to have to greatest 52-week period in the history of the U.S. stock market. When short-term sentiment is this washed out, stocks usually rip. 

Here’s Charlie Biello to sum it all up: “Just two weeks ago, we saw the highest percentage of bulls in the Investors Intelligence Index since 2020: 64.2%. That was an extreme reading, above 97% of historical data points. But last week the percentage of bulls moved down to 46.9%, which is right around the historical average. The 17% 2-week drop in the percentage of Bulls was the biggest sentiment swing we’ve seen since the October 1987 crash.”

 As we noted in the Monthly our Global Risk Nexus (GRN) work has really paid off reminding us that while volatility spiked in the market and politics segments it did not spike in the critical economic or policy spaces. Since these latter two drive earnings, rates and hence risk asset pricing our process suggested we should remain calm & stick to our knitting. 

We continue to see the political vol spike – the emergence of the Harris - Walz ticket as leading the US presidential race, as a risk asset positive in that it suggests a growing chance of a Dem sweep which suggests the continuation of the uber successful Biden – Harris economic policy mix. Here’s top Rep Pollster Frank Luntz on Harris: “She’s bringing out people who are not interested in voting for either Trump or Biden. So the entire electoral pool has changed. And if it continues in this direction, you have to start to consider Democrats winning the Senate and Democrats winning the House... I haven’t seen anything like this happen in 30 days in my lifetime.”

Recent economic data (inflation, jobless claims, retail sales) has come in with a positive and supportive risk on bias. We continue to utilize our 4 for 24 global macro surprises as guideposts with surprise #1, lower inflation, sooner than expected, in train, thereby setting up the Fed to join the global rate cutting party while better than expected productivity growth, surprise #2, continues to manifest and is the secret sauce for EPS growth in a 2% GDP growing economy. 

We also note the growing importance & rising recognition of the tight labor markets throughout the DM economies. This is fertile ground for productivity booms as noted here in Faster Please: “We're in an “era of tightness,” is what we call it in the book, which is really a structural condition of the labor market. And there are a lot of silver linings that come with eras of tightness: It translates into better real wage growth, it nudges and forces firms do capital-for-labor substitution, it pushes them towards the technological frontier in their respective areas, and all of that should lead into some boost of productivity growth.”

Surprise #3, return to stability – well, a VIX spike from 15 to 65 and back to 15 in under a month would seem to suggest a vol storm rather than a sustained rise. The former is a much better risk on environment than the latter. Finally, early cycle not late is surprise #4 and we remain of that view, that from a global economic POV we are early cycle not late. We are heartened in this respect by the solid US consumer data, data echoed in China of all places where retails sales came in well above forecast as well as Japan’s way BTE Q2 data showing Y/Y GDP growth over 3%. The global economy is in fine shape.

Of course, nothing helps stocks shake off fear better than solid EPS growth which Q2 results delivered not just in the US but in Europe and Japan as well as all 3 regions generated Y/Y EPS growth. It was the 1st Q in over a year where EPS growth ex Mag 7 was positive.

 We continue to focus forward and hang our hat on the 12 M forward EPS estimates for the US, EU and Asia - Pacific continuing to be up and to the right while US CEO recession fears collapse and small biz optimism surges. Latest update from the Conference board shows 70% of CEOs do not anticipate a recession in the next 12-18 months ... that's up from 29% a year ago

This week was our model update week (for both our Global Multi Asset (GMA) and our TPW 20 thematic model) and as is our process we reviewed the technical charts for all of our model holdings, benchmark constituents and any potential new adds. A few things stuck out with perhaps the most important being how few model positions saw a sustained break through their 200 dmav. Many went right to that level and bounced, suggesting that indeed it was a correction not the start of something more ominous. Those few that broke the 200dmav have bounced right back up through it. 

Many positions did break their 50dmav and have again climbed back above it suggesting perhaps the return to a rising market environment as evidenced by 6 straight up days for the S&P. Both SPY & ACWI just climbed back above that key technical level which technicians like John Kolovos at MRA Advisors noted as a key all clear signal. 

One thing that jumped out to us in our thematic model was the split between clean energy (ICLN) among the leaders and lithium/battery (LIT) among the laggards. We wrote in the monthly how the solar manufacturers in China were starting to demonstrate some discipline in their expansion plans and it looks like that segment is trying to make a bottom. The charts look completely different with ICLN above its 50, 100, 200dmav while LIT is well below all three.

We have also noted a sudden surge in support for our 2 tech stack divide thesis which argues that China tech is very attractive on both an absolute and relative to US tech basis. Q2 ownership reports have come out and lo and behold big names like Soros, Tepper and Burry all have very sizable positions in BABA specifically and China tech in general. BABA trades at 9x forward Earnings according to S&P Global. We continue to own KWEB in both models.

We remain constructive on risk and did not make many model changes at all – we remain fully invested & OW Equity and Commodities and UW FI. We note that GSG, the broad Commodity index, is right at its 200dmav while XLE & Dr. Copper as expressed via COPX are both above their 200D level. We like Commodities here. Our FI UW hurt the GMA model over the past month but we don’t see much appeal to a sub 4% 10 yr. given our growth outlook. We like the demonstrated resiliency of global cross asset markets, the global consumer and global economies together with the resiliency of corporates which continue to generate earnings through some pretty volatile periods. All this sustains our global macro blue sky outlook.

TPW Advisory is heading out on vaca as of COB today; please keep an eye on things for us will you? We will be back in your inbox come early September.