What a week we’ve had! The market has been volatile, but breadth increased and overall price movement was constructive.
The NASDAQ closed out its best first half of a year ever, with QQQ up nearly 40%.
The divergence between QQQ and TLT is the largest that it’s been in a long time. Taken in a vacuum it can be dismissed. But it actually comes with the rally coming from multiple expansion rather than improving earnings and concentrated in just about 15 names.
Equity risk premium remains at the lowest levels in over two decades. It makes a lot more sense to consider high grade fixed income in this environment than to have a lot of risk on in stocks.
We can see this divergence in NASDAQ earnings yield vs 5-year TIPS yield as well. It illustrates the same sort of picture we see in QQQ vs TLT. A long-term correlation that has some practical implications is diverging meaningfully.
We do see liquidity from central banks beginning to roll off, and that correlation with markets suggests that it may be a headwind moving forward. Particularly with Treasury issuance pulling more liquidity out of the market.
There is an alternative, and that alternative is the fixed income market. Treasury bills and AAA corporate debt both could be attractive here.
Volatility may be set to rise in the years ahead, as a peak in rates tends to have a two-year lag with the VIX.
Equity alternatives have become more attractive, with Treasury bills and bonds, corporate debt, and cash all potentially better strategic allocations at this juncture.
Hedge fund gross leverage is at a historic extreme at 258%, a five-year high. This increases tail risk as we could have situations where if markets move against these funds they have to unwind one or both sides of their books. Sometimes in a hurry. Which can both push share prices up and down depending on whether they are covering shorts or selling longs.
Speaking of shorts, regional banks are a favorite short of hedge funds, according to data from Goldman Sachs. Suggesting that perhaps that trade is a little bit crowded.
CTAs have little left to buy on a positively trending market, but with a momentum shift lower they will have between $10B and $70B worth of exposure to sell.
The great reopening that wasn’t? China’s stock market is looking increasingly precarious as the primary pillars of its economy, real estate and construction, are not growing.
Other signs of weakness within China, tourism has been subdued. This suggests that consumers in China don’t have the same pent up demand for travel that the US experienced.
High net worth individuals had significantly higher than normal cash allocations going into 2023. While money markets have seen outflows, they haven’t been significant. Suggesting much of this positioning remains intact.
Disposable income is increasing, but spending growth decreased to 0.1%.
In the UK we are seeing core CPI accelerate, while headline falls. Inflation remains a big problem.
Nextdoor in the Euro Area there has been a significant contraction in money supply, suggesting that industrial production may follow lower.
There has also been signs of weakness in Asia, providing ammunition for depreciating currencies. But also providing evidence that the global economy is slowing further.
US banks have had increasing interest costs, outpacing net income growth from rising rates.
Bank reserves are likely set to decline by a total of approximately $500B with the level of Treasury issuance we are seeing post-debt ceiling resolution
The US federal deficit has been reduced meaningfully since the COVID stimulus spending packages peaked, but it is still quite elevated, adding to some of the economic momentum we’re seeing.
Young borrowers are taking on more debt and the 20-30 age range is experiencing delinquency rate that we haven’t seen since the Great Financial Crisis.
Most of the student debt is owed by the next age group, 30-39, but 40-49 and 18-29 also owe a significant amount.
Rate expectations have shifted back to March from May after the cooler PCE data on Friday.
Inversions are customary “late cycle” signposts. Inverted FF/10s preceded each recession over the last 50 years; the FF/10s curve never inverted substantially without a recession following. - BofAML
US equity markets have been outperforming much of the rest of the world since the COVID crash.
Real estate has been the weakest sector since January of 2020 and tech has been the strongest.
Equity positioning is high, but it isn’t elevated to extreme levels according to data from Deutsche Bank.
The bank goes on to suggest it expects a modest drawdown of 3-5%.
But BNY Mellon has more aggressive downside projections (2500-3500).
Stress levels have dropped quite significantly within the financial system, which is a good sign. But it also suggests that many central banks have plenty of room to further tighten.
Home prices may be set to fall further in the UK. There’s a significant amount of mortgage rates resetting over this summer that is putting increasing pressure on a market that has already been slowing.
All over the world 10-year bond yields have risen, although in Japan that rise has been subdued significantly in no small part because of yield curve control by the Bank of Japan, who already owns over 50% of the country’s outstanding debt.
There are some positive signs in services inflation topping out just as ISM Services PMI last read 50.3, a reading that is only marginal expansion.
Finally, rising rates are constraining unsecured credit growth, which is likely to weigh on a debt-driven economy.
