Month: June 2020

In what is sure to elevate race tension to ’12’ (since they are already at ’11’), President Trump has responded to comments from the BLM movement’s leader earlier in the week:

Black Lives Matter leader states, “If U.S. doesn’t give us what we want, then we will burn down this system and replace it”. This is Treason, Sedition, Insurrection!

— Donald J. Trump (@realDonaldTrump) June 25, 2020

Trump’s comment follow comments by Hawk Newsome – who chairs Black Lives Matter of Greater New York  argued that because violence and rioting appeared to be getting the point across more effectively, those efforts were justifiable.

A tense exchange with Fox’s Martha MacCallum  lays out the details (and likely triggered Trump):

MacCallum began by quoting Newsome as saying that he wanted to “shove legislation down people’s throats,” and then asked him, “What exactly is it that you hope to achieve through violence?”

Newsome responded by claiming that the United States had been “built upon violence,” citing the American Revolution and arguing that American diplomacy largely consisted of blowing up other countries and replacing their leaders with leaders we liked better.

MacCallum responded: “The only reason I posed that first question to you the way that I did, I watched you talking on a bunch of different interviews today and you said, ‘Burn it down.’ You said it, ‘Burn it down, it’s time.’ So that makes me think that you want to burn it down.”

“If this country doesn’t give us what we want then we will burn down the system and replace it,” Newsome replied. “And I could be speaking figuratively, I could be speaking literally. It’s a matter of interpretation.”

This came on the heels of comments from another BLM co-founder earlier in the week. As we detailed earlier in the week, while massive protests continue to rage across the country (and beyond) in the name of George Floyd, Black Lives Matter co-founder Patrisse Cullors admitted during a Friday night interview with CNN that “our goal is to get Trump out.”

Cullors, who described BLM organizers in 2015 as “trained Marxists,” compared Trump to Hitler after refusing to meet with him, and referred to Immigration and Customs Enforcement (ICE) as the Gestapo, told CNN‘s Jake Tapper (via Breitbart‘s Josh Caplan):

JAKE TAPPER: I’ve heard a lot of criticism of former Vice President Joe Biden from civil rights activists. The election, obviously, will be a choice. How do you think Biden matches up compared to President Trump when it comes to these issues that are important to you?

PATRISSE CULLORS: Trump not only needs to not be in office in November but he should resign now. Trump needs to be out of office. He is not fit for office. And so what we are going to push for is a move to get Trump out. While we’re also going to continue to push and pressure vice president Joe Biden around his policies and relationship to policing and criminalization. That’s going to be important. But our goal is to get Trump out.

President “Trump not only needs to not be in office in November but he should resign now,” says co-founder of the Black Lives Matter Global Network Patrisse Cullors. “Trump needs to be out of office. He is not fit for office.” pic.twitter.com/T6mLZ11cEv

— The Lead CNN (@TheLeadCNN) June 19, 2020

In 2015, Cullors said that BLM would take “any opportunity we have to shut down a Republican convention.”

Was Tucker Carlson right when he said (and was punished with an advertiser walkout from the ‘cancel’ crew at Sleeping Giants) that Black Lives Matter is now a political party?

“Black [Lives] Matter is more popular by double digits than both the Democratic and Republican parties.

It is almost as popular as the U.S. military. It is much more popular than the pope.”@TuckerCarlson warns that the Black Lives Matter movement wields significant influence. pic.twitter.com/1AhsGqHBzo

— Washington Examiner (@dcexaminer) June 16, 2020

As shootings and other violent crimes skyrocket in NYC, Mayor de Blasio and his administration are focusing on pandering to the (mostly white) BLM marchers who took to the streets in the middle of an epidemic, while rioters and looters ransacked storefronts from SoHo to midtown to the Bronx.

And in the latest and perhaps most egregious example of a cop being punished for doing his job, an NYC police officer was arrested on Thursday morning and charged with strangulation and attempted strangulation over a controversial video that shows him apparently using a chokehold on a suspect after police were called to the scene to confront a group of hooligans who were harassing pedestrians and reportedly throwing stuff at them.

David Afanador, 39, the officer caught on video using the chokehold, had already been suspended from the force, before being arrested on Thursday.

In the video, as Reuters pointed out, the man who was arrested and several associates can be heard cursing and insulting the cop.

Here’s more from Reuters:

The NYPD has banned its officers from using chokeholds since 1993, warning they can be deadly. Earlier this month, as part of a package of police reform bills spurred by the nationwide protests against police violence, New York Governor Andrew Cuomo signed legislation making it a crime for officers to use chokeholds and similar neck restraints.

The forceful arrest on the Rockaway Beach boardwalk in Queens on Sunday was captured on police body-cam videos, which were released by the NYPD, and cellphone videos recorded by bystanders.

The videos show officers restraining the man on his stomach and one officer, Afanador, wrapping his arm around the man’s neck.

The man was arrested for being “disorderly” and was hospitalized after briefly falling unconscious in the officer’s grip, according to his lawyers at Queens Defenders.

The man, along with two others, could be seen cursing and insulting Afanador and his colleagues for several minutes prior to the arrest.
Scrutiny of the police has intensified across the country in the wake of the death on May 25 of George Floyd, a Black man, during an arrest in Minneapolis.

Video showed a white officer with his knee on Floyd’s neck for nearly nine minutes, giving rise ever since to some of the largest, most sustained nationwide protests seen in the United States in decades.

Meanwhile, sympathy for the police continues to wane amid a steady stream of stories like this one, where three Maryland cops were fired after being caught on tape discussing a “race war” and saying things like “we’re going to go out and start slaughtering them”, according to the Washington Post.

Authored by Irina Slav via OilPrice.com,

Amid record-breaking additions to the new Covid-19 case count in Texas, oil companies in the state have suspended plans to return staff to offices, Reuters reports.

Health officials in the state reported a record-high number of newly diagnosed cases yesterday, at 5,551, with another 4,389 people hospitalized with the viral disease–also a record number.

In light of this new data, Texas Governor Greg Abbott warned that the state is facing a “massive outbreak”, and some restrictions may need to be implemented to slow the spread of the virus. Abbott was among the governors pushing for a quick reopening of states after the lockdown.

“There are some regions in the state of Texas that are running tight on hospital capacity that may necessitate a localized strategy to make sure that hospital beds will be available,” Governor Abbott said.

“We are looking at greater restrictions and some could be localized,” he also said, as quoted by local media.

The reopening in Texas started on May 1 and was planned in several phases. Businesses, too, returned to work in phases. These phases have now been delayed, with Halliburton saying it will delay its planned return of staff to offices by two weeks, while Chevron has delayed the staff’s return to work until further notice. Only a small number of Chevron’s staff work at its offices in Houston and San Ramon, Reuters reported.

Exxon has not yet revised its return-to-work plans, with less than 50 percent of staff to work at its Houston-area offices. 

ConocoPhillips has also not yet made changes to its plans but will make them if necessary, according to a spokesperson who spoke to Reuters.

The Texas oil industry shed a record 26,300 jobs in April alone, at the height of the pandemic-caused crisis, leaving about 192,600 people employed in the industry, which, the Houston Chronicle said, was the lowest employment number in Texas oil and gas since 2016, at the height of the previous oil price crisis.

After a medicore 7Y auction last month, but following a very strong 5Y auction yesterday, moments ago the Treasury sold a record $41 billion in 7 year paper at the lowest yield on record, or 0.511%, 0.5bps through the When Issued 0.516%, with strong internals, confirming that there continues to be no shortage of demand for Treasury paper.

With a total of $41 billion in paper looking for buyers today, the largest amount for a 7Y auction ever…

… there was $102 billion in bids tendered, resulting in a bid to cover of 2.49, just shy of last month’s 2.55, and on top of the 2.53 six-auction average. While this was the lowest bid to cover since February, it is well above the prevailing level of BTCs during much of 2019.

The internals were also solid, with Inidrects taking down 62.6%, below last month’s 63.6%, but just above the recent average of 62.1%. And with Directs taking down 15.7%, the most since January 2020, Dealers were left holding just 21.7%, below May’s 24.0% and below the recent average of 24.3%.

Overall a strong auction, which like yesterday, benefited from the relatively flat market in TSYs today, where the 10Y is trading about 1bp below the Thursday close.

The Dixie Chicks have changed their name ahead of their first album in 14 years, dropping the “Dixie” and renaming themselves “The Chicks.”

The move comes amid national protests over the history of race relations in the United States – and was perhaps inspired by a Jun 17 article in Variety titled “After Lady Antebellum, Is It Time for the Dixie Chicks to Rethink Their Name?”

As Variety‘s Jeremy Helligar writes:

“Dixie,” for the record, is the epitome of white America, a celebration of a Southern tradition that is indivisible from Black slaves and those grand plantations where they were forced to toil for free. The origin of the word, though, is unclear. One theory links it to Jeremiah Dixon, who along with Charles Mason, drew the Mason-Dixon line as the border between four states that later became the unofficial separation between free states and slaves states. Other less likely theories trace it back to a slave owner from Manhattan as well as “dix,” a word written on Louisiana’s 10-dollar bills pre-Civil War that’s French for “ten.” –Variety

On Thursday, “The Chicks” – Natalie Maines, Emily Strayer, and Martie Maguire  – released a new single from their upcoming album, Gaslighter, titled “March March.”

As Rolling Stone describes it: “Lyrically, Maines addresses everything from Greta Thunberg and youth climate protests to gun violence and underpaid school teachers, over a music video that edits together footage from recent Black Lives Matter protests and police confrontations. Toward the end, as Maguire dives into a fiery fiddle solo, the names of black Americans killed by police flash onscreen, and the video concludes with a message from the Chicks — “Use your voice. Use your vote.” — along with links to various social justice organizations and nonprofits.”

In 2003, the band drew condemnation when they told a London audience they were “ashamed” of President George W. Bush, leading to boycotts and a lengthy hiatus.

Chicks is derogatory toward women. They are now”the”.

— ty jones (@TylerScottJones) June 25, 2020

Via Global Macro Monitor,

Summary

• The financial media is beginning assign blame to the recent stock market weakness to the spike in COVID cases and the potential for a November Democratic sweep of the White House and both chambers of Congress

• Nothing new to GMM as we have been on this early and stood alone

• The stock market’s valuation is at a historical extreme

• The stars are aligned for a nasty and protracted bear market. Timing is anyone’s guess

• The Fed has created an asset scarcity induced stock market bubble, similar to the Beanie Baby bubble of the late 1990s

In graduate school,  Rudy Dornbush, Jacob Frankel, and Michael Mussa, all giants in the field of macro and international economics,  gave a seminar to our economics department.  I was invited to dinner with them along with the department’s international economics professors.  The one take-away from that dinner was a comment seared into my mind by Jacob Frankel, who went on to become the Governor of the Bank of Israel  and now serves as Chairman of JPMorgan Chase International.

Why Markets Do What They Do

Over dinner, he laughingly mocked the financial media for their propensity to assign specific reasons for why the market did what it did on a daily basis.  He quoted two diametrically opposed and contradictory headlines, one from the NY Times and the other from the LA Times, which explained why the market was down that day.   That comment has stuck with me throughout my career — nobody knows what really causes the stock market to do what it does on a daily basis.  The best, and the safest explanation I have heard on a down day, for example, is  “there were more sellers and buyers,” which doesn’t even suffice.  The comment should be qualified, “there were more sellers than buyers at yesterday’s closing prices.”

In a free market that clears — which are rapidly moving toward extinction with the Fed’s backstopping of almost everything — buyers always equal sellers.  It is prices that adjust to allow the market to match-up sales with buys.   It is increasingly obvious the Fed can’t allow markets to operate freely as the economic consequences of allowing prices to move to their equilibrium and fair value are not politically palatable or maybe not even be possible without blowing up the global economy.

Conversation With Coach Carol

Before proceeding, a sidenote on last night’s (Tuesday)  conversation with GMM’s crack stock-picker Coach Carol, who has a much longer-term view and a much better track record than yours truly.  She was much less sanguine on the market than I can remember and has been trimming her positions, concerned about the end of the quarter positioning and profit-taking by institutional investors.   Our ears perked up.

Unfortunately, she has been sidelined, bravely battling a relapse of ovarian cancer, and has not been able to post as much. But she did remind us,

“there will continue to be individual companies that will continue to grow and thrive regardless of market conditions. Not everything collapsed during the mass shutdowns of Covid-19, indeed some companies thrived and shot to new ATHs. One needs to be far more disciplined and selective in choosing which stocks are appropriate to hold in a bear market. Also consider your tolerance for risk, because markets will be more volatile in a bear market.“

I also had a little health scare last week and have been unable to update her recent sales, which I will try to get to over the weekend posting the trade tickets with a timestamp.

Reason Du Jour For This Week’s Sell-Off 

Nevertheless, the financial media attributed today’s sell-off to two major factors:

1. The novel coronavirus infections setting a single-day national record.  Even though COVID related deaths have lagged the new cases, experts believe its only a matter of time before they catch up, 

Deaths always lag considerably behind cases,” Anthony S. Fauci, the nation’s top infectious-disease specialist, told Congress at a hearing Tuesday. In the weeks to come, he and others said, the death toll is likely to rise commensurately.  – Washington Post

Hat Tip:  @Sundae_Gurl

*  *  *

2. The increasing potential and rising crest of a Blue Wave in the November elections, where the Democrats take control of the White House, the Senate, and the House.

“This to me is a Biden move,” Jim Cramer said Wednesday as the market sold off. “When I see across the board selling today, that’s Biden … he sounds like another president that you get that is not favorable to capital. If that’s the case, I want to have a little cash.”  – CNBC

See the article here.

See the article here.

See the article here.

Nothing New Here 

Readers of the GMM should not find any of the above either novel or surprising as we have been all over both, early and alone.

We are growing increasingly bearish on America’s prospect to arrest the spread of COVID-19 due to growing restlessness over the shelter-in-place rules leading to quarantine fatigue, weak political leadership, and lack of uniform measures to mitigate the spread across, and within, all fifty states. 

– America’s Bearish Day At The Beach, GMM, April 25th

If the November election is legit, a big if, it will be a freaking blow-out.

We have our money where our analysis is, betting on a Blue Senate, and if we are right, we are looking at a 439.11 percent compounded annual return (CAAG) by election day.  Beat that in the stonk market, folks.

–  Prepare For The Senate To Flip, April 13th

Market In Denial 

Corporate taxes are going higher and so are capital gains taxes.

Biden is already on record saying he wants the capital gains tax —  15-20 percent on most assets — to correspond to ordinary income tax brackets (currently 10%, 12%, 22%, 24%, 32%, 35% or 37%).  And don’t expect the income tax brackets to remain at current levels either.

The tax changes, especially on long-term capital gains, will go along way in making the U.S. tax system appear “fairer” and will eliminate the nonsense, such as following,

Mitt Romney made $13.7 million last year and paid $1.94 million in federal income taxes, giving him an effective tax rate of 14.1%, his campaign said Friday.

His effective tax rate was up slightly from the 13.9% rate he paid in 2010. — CNN Money

The market seems to think it’s business as usual and not one peep about this from the FinMedia geniuses and the potential for massive tax selling as the general election approaches.

You know our mantra, folks, always best to panic sell before everyone else does. — GMM, June 18th

Mocking Of The Whales And Extreme Valuation

We have written in several posts that when the idjit trading newbies begin to mock Warren Buffett is is time to beware,

Cue the “Buffett is an idjit” Tweets.  Then run like hell.  — GMM,  June 9th

But this one really takes the cake,

Dave is right. The “liquidationists” are still bitter that the Fed changed the rules in mid-March. Our job is not to opine on the rules and environment, just invest in whatever environment exists. https://t.co/mLIdr5RP1g

— David Schawel (@DavidSchawel) June 23, 2020

Howard Marks, a liquidationist?  You’ve got to be shitting me.

My money is on and with Buffett, Marks, and Grantham.  Anyday, anytime, all the time.

“To paraphrase Jeremy Grantham, we now find ourselves in the top 1% of stock market valuations and the bottom 1% of economic outcomes.”
—@jessefelder

— Roro (@rorotrader) June 24, 2020

Valuations

The macro gang at GMM has been out of the market for several months and won’t even think about a long-term position until the market valuation becomes much more attractive, which is a long way down.   We defer to our stock-picker, Coach Carol,  to scout out individual stocks with special stories where money can be made even in a bear market.

Our favorite valuation metric illustrates the stock market is currently at an extreme valuation level.  We concede the metric should be helped by a record GDP growth print in Q3 and that record low-interest rates and unprecedented Federal Reserve market intervention be considered to normalize the number.  But still, come on, Mr. Market, stop deluding yourself.

Upshot

The stars are aligned, the moon is in the seventh house and Jupiter is aligned with Mars for a nasty and protracted bear market.  The political winds are blowing against capital, the robustness of the economic recovery is growing increasingly uncertain, and globalization, the main driver of the secular bull market is in retreat.  The timing is anyone’s guess, however.

Fed Induced Asset Scarcity

The Fed, with its massive quantitative easing,  removing trillions of dollars of assets from the markets, has created a scarcity induced Beanie Baby-like stock market bubble,

..the little bean-filled sacks were more than a toy: they were an investment vehicle. Fueled by a rabid collectors’ market, Ty Inc. had just exceeded $1B in annual sales. Certain “retired” characters were going for as much as $13k on the resale market — 3,000x their original price.

…his [ Ty Warner] biggest stroke of genius came in 1995, when he surmised that if he “retired” certain Beanie Babies after a short period of time, it would create an illusion of scarcity (in reality, Ty was pumping out millions of them in overseas factories).

After being retired, Beanie Babies that sold for $5 would go for $15-20 — and on the internet, some sold for as much as $13k.

…One night in 1999, Ty announced the retirement of several Beanie Babies… and nothing happened. No market swell. No value increase. Nothing.

It was the beginning of the end. Collectors panicked and took to eBay to sell off huge swaths of the toys, flooding the market with a massive surplus of Beanie Babies. Their value, which was contingent on the illusion of scarcity, plummeted.

In a desperate bid to save a sinking ship, Ty announced that all Beanie Babies would go out of production at the end of 1999. It didn’t work. — The Hustle

Yes, we get it, Apple’s stock is not a beanie baby.  We used the analogy to make a point.  Spare us the emails, please.

As always, we reserve the right to wrong.

Over a dozen businesses, property owners and residents filed a class-action lawsuit against the city of Seattle on Wednesday over the decision to cede a roughly six-block area to BLM protesters, who then established the Capitol Hill Autonomous Zone (CHAZ) – now known as the Capitol Hill Occupying Protest (CHOP). 

Plaintiffs – which include several property management firms, an auto repair shop and a tattoo parlor, say the absence of police, firefighters and ambulances has subjected them to “extensive property damage, public safety dangers, and an inability to use and access their properties.”

That said, the plaintiffs want everyone to know that they support Black Lives Matter “who, by exercising such rights, are bringing issues such as systemic racism and unfair violence against African Americans by police to the forefront of the national consciousness.”

In short, they support the movement – just not the harms they’ve suffered as a result of it.

DEVELOPING: More than a dozen businesses inside CHOP zone, on Seattle’s Capitol Hill, file 56-page class action lawsuit against the City of Seattle. They’re seeking unspecified damages, to be determined at trial. pic.twitter.com/RPlsW3DuNv

— Preston Phillips (@PrestonTVNews) June 25, 2020

The occupation began after the Seattle Police Department decided to simply pull out of the neighborhood after days of escalations led to the deployment of tear gas and other crowd control measures. Instead of holding the line, SPD pulled out of the Capitol Hill neighborhood – after which rioters stormed the city’s East Precinct and claimed it as their own.

Since then, there have been three shootings on consecutive nights which began last weekend.

In response, Mayor Jenny Durkan said that the city would shut CHOP down – by encouraging demonstrators to leave voluntarily so that police could retake their precinct.

Patty Eakes, an attorney for the plaintiffs, separately told Durkan in a letter Wednesday that she wanted the mayor’s office to provide a timeline by Friday for clearing out the protest and returning police, or the plaintiffs would ask the court for an immediate order that full public access be restored.

“City leadership have been on the ground daily having discussions with demonstrators, residents and businesses and trusted community-based, Black-led organizations to determine a path forward that protects the right to peacefully protest and keeps people safe,” the mayor’s office said in a written statement.

In the class-action lawsuit, filed in U.S. District Court, about a dozen businesses, residents and property owners said they had sometimes been threatened for photographing protesters in public areas or for cleaning graffiti off their storefronts. The owner of the auto shop Car Tender said a burglar broke in the night of June 14, started a fire using hand sanitizer as an accelerant, and then attacked his son with a knife when confronted.

The owner and his son managed to put out the fire and detain the burglar, the complaint said, but police never responded to their 911 calls. A large crowd of “CHOP participants” then came to the scene and forced the owner to release the arsonist, it said. –Washington Times

Other businesses said they were unable to send or receive packages because delivery companies refused to enter the protest zone, or because their loading docks had been blocked by barricades.

Plaintiffs are seeking damages for property damage, lost business, deprivation of their property rights and demand that full public access be restored to their businesses.

Read the complaint below:

Authored by David Robertson via RealInvestmentAdvice.com,

If ever there was a mantra in the investment world, it is that you have to diversify. Everyone knows that combining uncorrelated assets into a portfolio reduces the risk of destructive drawdowns. For several decades now, the iconic way to realize diversification in investment portfolios has been through a balance of 60% stocks and 40% bonds (60/40).

This approach has worked brilliantly and has allowed countless investors to sit back and watch their retirement dreams come true comfortably. Unfortunately, those halcyon days are coming to a close. It is time for investors to start considering alternative ways to balance their portfolios.

The 60/40 Model Worked

There is no doubt that the 60/40 model has worked. Phil Lynch of Russell Investments, for example, shows that between 1926 and 2019, “a balanced 60/40 global stock/bond portfolio has provided competitive returns …” According to investment bank Goldman Sachs, the Financial Times adds: “A US 60-40 portfolio in the decade to 2020 produced its highest volatility-adjusted returns in over a century.”

There is a caveat, however, and it is one that many providers of investment services use to make a point. Those attractive returns have only been “for investors who stay invested during turbulent markets.” The message is that if you even so much as think about getting out of the market, you risk forfeiting handsome returns.

It is not good to jump out of the market at just any little hint of turbulence. But nor is it a good idea to assume that the landscape never changes and that risk and reward are static. Indeed, a great deal of evidence is accruing that now is precisely the time investors and advisors should be carefully re-assessing the strengths and weaknesses of the 60/40 strategy.

For starters, the historical performance of the 60/40 portfolio is considerably less robust than it first appears. Chris Cole from Artemis Capital Management points this out in a terrific piece of research entitled The Allegory of the Hawk and Serpent (h/t Grants Interest Rate Observer). He highlights: 

“A remarkable 91% of the price appreciation for a Classic Equity and Bond Portfolio (60/40) over the past 90 years comes from just 22 years between 1984 and 2007.” 

In other words, the performance for other periods was much less impressive.

The Cracks Appear

Also, further cracks in the case for the 60/40 appeared earlier this year. According to the FT, “the 60-40 strategy suffered one of its worst performances since the 1960s, as the bond rally proved insufficient to offset the tumble in stocks.” 

While instances of bad performance happen, and stocks were undoubtedly part of the problem, it was especially unsettling that bonds did not do their job this time.

The monetary policy response to Covid-19 in the first quarter also exacerbated challenges. The FT added: 

“Covid-19 has brought us to a historic turning point in financial markets. A fundamental investment strategy that has protected institutional and retail investors alike for decades — balancing equity risk by holding high-quality government bonds — has finally run its course. When the Fed lowered short-term rates to zero in response to the pandemic, the last shoe dropped.”

In retrospect, it is easy to see why bonds provided such a powerful combination with stocks. Not only did investors receive insurance in the form of diversification benefits, but they also got paid for having that insurance by receiving coupons. It was one of the scarce instances in which investors got to have their cake and eat it too.

That blissful situation has changed, however, and the FT goes on to describe how:

“Now that double benefit has turned into double jeopardy. As main central banks have lowered interest rates towards zero over the past decade, the yield component of the return on a portfolio of government bonds has evaporated. That leaves capital appreciation as the sole source of future returns. But the room for prices to rise has arguably all but disappeared too.”

Investors must now face the music. Their beloved and productive 60/40 strategy can no longer accomplish what it has achieved for so long. It will be missed.

“For investors who hold the classic 60/40 portfolio, this is a disaster. They have lost a reliable source of return, and their diversification strategy is broken.”

The Quandary

This difficulty is raising questions by investors of all types. Rusty Guinn from Epsilon Theory reports, “What is fascinating to me is that within a week, a professional market research shop, a personal finance writer and a financial markets journalist all took on the question of ‘the role of bonds’.”

“But I can observe that enough people are thinking about it – and enough people know that other people are thinking about it – that common knowledge is forming around the question.”

In other words, the issue of the role of bonds is becoming a thing. It is undoubtedly a thing among fund managers as the FT notes:

“Investors are now grappling with the implications. In Bank of America’s investor survey in March, 52 percent of fund managers said that US government bonds were the best hedge against turmoil. That share dropped to 22 percent in April.”

The Role Of Bonds

The fact the industry is discussing the role of bonds is good news in the sense that the industry is adapting. However, it also means that if you are not working through these things yourself, you fall behind the curve.

More is needed than just discussion though. Identifying specific alternatives to take the place of the diversifying role of bonds. The FT offers some suggestions, some of which are simple and some of which are a lot more complicated:

“In seeking new sources of ballast for balanced portfolios, asset allocators will have to think about alternatives to bonds, including cash, gold, cryptocurrencies, and explicit volatility strategies — such as put options directly hedging equities — with which they may be less familiar. There are pros and cons to each selection, but the key point is that, with the diversifying power of bonds gone, there is no longer any natural choice.”

These ideas are extremely helpful in framing out possible replacements for bonds in balanced portfolios. Managing expectations is important. These replacements are unlikely to provide the same types of returns that bonds have, but they are less likely to offer the same diversifying effect as bonds have. On top of all that, some of these options are unfamiliar and uncomfortable for some investors.

The Days Are Numbered

While the days of the 60/40 strategy are numbered, the more general lesson to keep in mind is that things always change. Therefore, it is important to remain flexible and open-minded to deal productively with those changes. As John Hussman explains, these traits are likely to be extremely important in dealing with investment challenges ahead:

“That ability to respond to changing market conditions in a disciplined way is the one thing that passive buy-and-hold investors don’t have. I strongly believe that it’s the primary factor that will determine investment success over the coming decade. Lacking a flexible discipline, my view is that passive investors are doomed to go nowhere in an interesting way over the coming 10-12 year horizon.”

So, it’s never easy to replace something that has worked well for a long time. In this sense, replacing the 60/40 strategy is like bidding farewell to a retiring star athlete. We can all remember and respect the terrific accomplishments of the past and recognize that younger players are now more capable of competing at the highest level. Overly sentimental attachments will prevent progress; it is best to make the change and move forward.

Global equity markets dropped steeply yesterday, with Nomura quant Masanari Takada summarizing that this probably indicates “that the bulls and the bears are deadlocked, and that it is best not to let one’s decisions be swayed too much by day-to-day market fluctuations.” However, Takada adds that it is important to properly understand what is going on, if only from a purely positioning and short-term quantitative strategic viewpoint.

Below he explains what was behind the sell-off and what one should do about it.

For better or worse, investor sentiment has been deadlocked between its bullish and bearish impulses. Into the context of this stalemate in sentiment came market-negative headlines concerning a second wave of the coronavirus pandemic and trade tensions between the US and Europe. The news flow caused the balance of sentiment to break down and tilt to the bearish side. However, according to the quant, other causes explain why the drop in US stocks was so steep.

First, hedge funds’ current  stance in the aggregate can be described as “cautiously bullish”; one pictures them stepping on the accelerator and the brakes simultaneously. A sell-off makes them more inclined to brace against downside through such means as buying puts, and this in turns seems to have resulted in an upward bump in implied volatility (as measured by the VIX and other indicators).

At the same time, the VIX futures term structure has gone into backwardation, as the accumulation of long positions by discretionary traders and trend-following players has lifted prices for near-dated VIX futures. This seems to have encouraged some speculative investors to cover short positions in VIX futures.

Second, some investors may be expecting longer-term investors (pension funds and other end investors) to sell stocks for the sake of portfolio rebalancing. With the current quarter about to end, longer-term investors may indeed do some automatic selling of equities as they adjust their portfolio weightings. However, a look at the US equity exposure of major US mutual funds (one-month beta estimate) reveals that these mutual funds do not have excessive equity holdings, nor are they even overweight. If anything, unlike JPMorgan which expects up to $170BN in selling, Nomura thinks they may have executed what little selling they needed to when adjusting their portfolio weightings in April-May after swinging to buying stocks when rebalancing their portfolios at the end of March.

To be sure, Takada admits that JPM may well prove to be right, as major US mutual funds are just a small fraction of the overall pool of longer-term investors and it is difficult to come to any clear conclusions about that larger pool of investors. Therefore, Nomura concedes that one should not rule out the possibility of longer-term investors selling equities for the sake of rebalancing, but since these investors tend to have a strong contrarian bent, the whole notion may be simply be an excuse for short-term investors to take a speculative stab at selling equities.

What should traders do? In short: stay pat until around 6 July if market stays stuck in “pattern rut.”

Currently there is a lot of extraneous noise that has nothing to do with the market per se, such as the second wave of the coronavirus pandemic and the Europe-US trade dispute, but vital market liquidity looks to have been left intact. Furthermore, compared with the drop in equity prices, the decline in sentiment looks moderate. The market does not seem to be factoring in unthinkable conditions. Overall, hedge fund net exposure to US equities and DM equities still does not look excessive, and we see little risk of a chain-reaction sell-off of equities by systematic traders (CTAs and risk-parity funds). If the broadly prevailing preference for high-beta stocks by speculative investors continues, then US stocks may well claw back yesterday’s losses in just a few days.

However, a lack of positive news tends to result in the market falling back into “pattern ruts” that give rise to a surface appearance of risk-off conditions. The point here is not the second wave of infections itself but whether trades can be premised on tying the “pattern rut” to the second wave. In such a case, it would probably be necessary to prepare strategic positions that assume the continuation of risk-off conditions through around 6 July.

Finally, Nomura notes that daily trading reconfirms that the markets are stuck in something of a “pattern rut”. In the interest of avoiding promoting haphazard trading ideas in reaction to short-term upswings or downswings, our basic stance has been to always check whether seemingly irregular phenomena may in fact be following the market’s particular rhythms. In other words, we try to determine whether trading flows optimized for a particular time on expectations for a specific event actually have a meaningful effect on the largely automatic asset price movements that are driven by set patterns of human behavior and preferences and by regular periodic flows.

From this perspective, while at this stage there are no irregular risk-off movements, there is a heightened probability of an automatic risk-off pattern (a “pattern rut”) in response to the drying up of specific risk-on flows.

First, in terms of factors for US equities, the selling of value stocks and buying of momentum stocks that started on 12 June could continue through mid-August. The first wave of factor reversals historically seen after risk-off events has already passed by, and we are now in a phase in which these reversals are being reversed. This factor pattern is also likely to be playing a part in the recent renewed buying of stocks that benefit from the pandemic (pharmaceuticals and stocks related to stay-at-home demand).

Second, CTAs’ adjustment of their long positions in S&P 500 futures could continue through around 6 July. Their upside-chasing looks to have failed to break out of the “pattern rut”, and they seem to have shifted to wait-and-see mode right on schedule. If the S&P 500 were to break below the inflection point at 3,030-3,050 (the cost of net buying of futures in June), they look prone to position adjustments until around 6 July

As CTAs’ long positions in NASDAQ 100 futures break even around 8,900 (the cost of new buying since April), they are likely to be looking to buy on dips for now, even as Nomura estimates that they have gone net short again on Russell 2000 futures.

In fact, CTAs’ trading of NASDAQ 100 and Russell 2000 futures could be said to be determined by “pattern ruts”. Portfolio performance for US high-P/B stocks versus small-cap stocks, like the first point mentioned above, look very much to be following a predictable pattern of outperformance.