May 2019: Is anything really right or wrong ?
Until mid April, investors have been convinced that a market correction was coming. Then, at the exact time the market topped, they have become finally bullish and are now convinced that buying the dip is the right strategy. Is it really right ? We have been looking back at how political sentiment (the fear of a war in North-Korea, the fear of Marine Le Pen winning the French presidential elections, the fear of President Trump embarking on a trade war…) has been driving investor positioning over the past 3 years. In our view, the consensus position has consistently been proven wrong, and it is more the contrarian approach that has been right up to now.
In our view, the right approach is to focus on selling the rallys (or even the breakdowns), rather than to fixate on calling the rebound. Markets face a weaker economic environment, with surprisingly little inflation, lower earnings growth and the disappearance of the ‘wall of worry’ that supported it year to date explosive rise. Our regional matrix is still constructive on equities on the medium run, but its short term view (one month) is definitely bearish. We are now in the weakest period of the year in terms of seasonality, and a number of political headwinds have re-appeared – Trade wars, Trump impeachment, Middle-east/ North Korea, the European elections and forever the Brexit).
So we have seen markets rise to the end of April and corrects 4% during the famous « sell in may » period (which most strategists deny would materialize). Will this be followed by another 5% down instead of a steep rise to the year end?
Two years ago, while being a Strategist for Pictet, we flew to meet our Canadian and US clients to discuss our viewsfor the end of the year. Following one long meeting, and with some time to kill before the next one, we found ourselves under Washington Square Arch. Three Swiss bankers, we sat down on a bench surrounded by hippies and activists, and there we spent a happy hour listening to some great classic rock songs played by an aging busker to whom every passing hippy gestured a casual peace sign as they walked by.
As I tapped my feet and soaked up the atmosphere, two placards caught my attention. The first one said: “Is anything really right or wrong?” . As a taste of a madeleine dipped in tea gives you sudden clarity on a time gone by, I had a sudden realization. All year, so many investors have been expecting a market correction. They were convinced it was ‘right’ to be short stocks after the December debacle, and by the end of April that the rally was there to go on in a melt-up fashion (let’s directly fly to 3200), and once the unexpected correction « sell in May and go away » arrived, they are convinced to buy the dips. Mr Placard Man was on to something : is anything really right or wrong?
Holding that thought, I turned to consider the man sitting next to him. He held a second placard, which read: ‘Did mind create matter OR did matter create mind?’
My philosophising continued: Has it not been the ‘mind’ – the fear of missing out the rally, driving the current buy the dips mentality… that has driven investor behaviour this year, manifesting itself in consensus positioning? Yet over the past year, the consensus has consistently been proven wrong, and it is the contrarian approach that has been proven right. What is the consensus telling us now ? If you cast your mind back, you will remember that last week was the week Barron’s leading article was about how the bull market was going to resume and that one should « KEEP CALM »; It was also the week when a survey on US mutual Funds revealed that they are underweight cash at 2.9% or the lowest level ever, and that Advisors investment model was at a too high statistically for a bull market. Even European hedge funds which were so cautious all year have finally increased their longs and their net exposures in the last weeks. What’s more, the intraday behaviour of the market (overnight sell-off followed by intense intraday buying) demonstrates the buy the dip mentality that prevails now. While we think that equity markets are yet to price in the risks of a larger, more sustained trade dispute, which could put downward pressure on global growth expectations through 2H19 and beyond, The Economist just made its cover page on the booming US jobs market ( just remember when they made a call for oil to fall at 10$ just at its multi-years bottom).
So, Back in my philosophical bubble in Washington square, gazing at my new prophet I think to myself: “Is it really right that the equity market will be up from current levels between now and the end of the year?” I feel he gives me my answer: “No”. Should we not first consider the ‘matter’ (weaker economic data, an evolving earnings recession, the slow de-construction of Global trade, the rise of the US-china clash of civilization). While there are a number of healthy underlying fundamentals, including strong job growth ( see the Economist cover again), healthy balance sheets, and supportive fiscal and monetary policies, much of the 1Q GDP strength based on one-offs (US inventories, fading EMU industrial and political disruptions, and reconnecting Asian supply chains) and with the latest escalation of the US-China trade war, the headwinds are likely to continue. We easily marry our matrix (which is bearish short term on everything) with an anti-consensual approach by articulating our trades and net exposure with a sell the rally approach instead of a buy the dip mentality. We have done it all the month of May, and that has proved very successfull as we are up 2% mtd while the MSCI world is down 3.5%.
Washington Square is well known for its bohemian, rebellious character; a ‘temple of hippies’ in the capital of capitalism, often associated with left-wing writers and philosophers such as French Jean-Paul Sartre. In fact, one of Satre’s most famous quotes, “existence precedes essence”, chimes with both the placards and our thoughts on how to approach the market. It means that first of all, man exists, and only once it exists does it define itself and therefore ‘is’. With reference to our second placard, ”Did mind create matter or did matter create mind?” perhaps Satre would answer : ‘matter creates mind.’ So, let’s focus on the facts (lower economic data, evolving earnings recession, renewed trade wars, hard Brexit etc.) when considering our trades, and pay less heed to the mind (and the prevailing rhetoric that market must rebound etc.). For once, as capitalists, let’s feed our mercantilist approach on existentialism and Washington Square magic : let’s let facts make up our mind and let’s short risky assets on all rebounds!