Some interesting laments from Morgan Stanely’s chief cross-asset strategist Andrew Sheets as he explains what appears to be troubling not just Morgan Stanley’s traders and researchers, but virtually all of Wall Street.
How Can a Good Year Be Bad?
If there’s a defining characteristic of 2016, it may be that few are enjoying it. Investors who entered the year optimistic were often forced to take losses by the year’s unrelenting start. Investors who entered the year negative often struggled to turn this around quickly enough as illiquid markets bounced ferociously off. Through the end of April, the average macro hedge fund was down 0.4% and the average long/short equity fund was down 3.8% (per Hedge Fund Research Indices). And if you work on the sell-side, 2016 hasn’t exactly been a barrel of laughs either.
We dwell on these difficulties only because, by a number of measures, 2016 hasn’t been bad. Global equities are down by only 0.6% YTD, despite the sharp fall at the start of the year. Global high yield is up 7.3%. EM hard-currency debt is up 7.6%. Oil is around 28% higher than where it started the year, and even global government bonds are up 8.4% on the year. US and emerging market equity volatility is now below the long-run average. As I write, I’m sure there is an individual investor in my hometown of Portland, Oregon sitting on a 50:50 portfolio of US stocks and bonds, soundly beating a large number of macro hedge funds.
For the rest of us, that’s precisely the challenge. Reasonable YTD returns are the result of significant normalisation in a short period (or, in the case of fixed income, an unsustainable rally in global yields). For German 10yr Bunds to produce the same four-month Sharpe ratio as they have through April 30, you’d need yields to hit -0.3% and volatility to realise at the lowest levels ever seen. Possible. But unlikely.
What this means, unsurprisingly, depends on who you ask. Many of our traders (whose views are, and should be, short term) are more likely to view this shortfall in YTD fund performance (among other factors) as a positive near-term technical. My research colleagues (who tend to focus on somewhat longer horizons) tend to sound more downbeat, and more worried about those normalised valuations and our below-consensus economic forecasts. And investors, understandably, are torn between the fear of buying now and top-ticking the market, and doing nothing and cementing sub-par gains.
In our view, two things are important as the summer approaches. First, the outlook for total return, and ‘beta’, does not look great. Bonds are very rich. Equities are modestly rich. Credit is better, but has re-priced significantly. The trade-off we see between volatility and our long-run return forecasts is lower than at the start of the year.
And yet, this uninspiring high-level picture gives way to quite a bit below the surface. We thought we’d struggle to find ideas for our Cross-Asset Playbook this month. We had too many. We think there is opportunity to be outright long in Greek government bonds, leveraged loans and CLO AAAs. We see good relative value in healthcare versus staples, Treasuries versus Bunds, and USD versus KRW. And we see reasonable ways to protect against potential summer volatility (at reasonable cost) by buying JPY, selling GBP, and taking advantage of low US and EM equity volatility.
It’s been a tough year. The summer does not look easy. Many of us haven’t done well enough to pack it in and head off to the beach. If that’s the bad news, the silver lining may be that pricing within and between asset classes is throwing up an outsized number of interesting opportunities.
via http://ift.tt/1V48yDK Tyler Durden