By Goldman trader and managing director, Bobby Molavi
Last week was truly a tale of two halves. The start of the week seeing hope around China reopening but this quickly made way to denials and a subsequent 3% decline for the SPX from Tuesday highs on increased focus on micro headwinds, job losses and deteriorating consumer backdrop. Then it was all change. The end of the week saw a 7% rally across Thurs/Friday for SPX on better than expected CPI and renewed hope that inflation and therefor rates were/had peaking/peaked. To put into context, Thursday saw one of the single biggest financial conditions easing on record….and I think it is fair to say, that not many were positioned for that trade.
The CPI numbers themselves indicated a slow down in rents, in used cars and in other areas such as inflation. This also came at a time where we saw a material ratcheting up in unemployment related headlines. Just in the last few weeks….Meta has laid off 11k, Twitter close to 4k, Robinhood around 30% of work force, Stripe around 15% of work force, Amazon a record 10,000 …even those who are ‘out performing’ like Apple have announced hiring freezes. Tech may not employ people commensurate with their market cap but in my mend the sector is much more interconnected into old economy and main street than it was in 2000. Where Tech leads I would imagine others to follow.
How much should we extrapolate from last week? For me, not much. We continue to see the sell side (including us) revise down EPS for 2023 and investors continue to argue that corporate margins have peaked and ability to pass on costs to consumer are now capped. In terms of last week market moves…it shows me that muscle memory (how to trade the low rate/fed support era) remains strong, and in an environment of light positioning, light liquidity and positive news I am not overly surprised by the scale of the move. Worth noting that between June 2000 and November 2001 the market saw 3 separate 30 to 40% rallies on it’s path from 4750 to 1083 (-78%).
What is clear about last week is that 2022 is for many fundamental investor a true “annus horribilis.” You spent the first 6 months of the year u/w banks/oils and overweight tech only to gradually (and painfully) correct that wrong way set up only to be dealt a 9th inning punch in the gut. As of last week Longs were longer cash than at any point in the year only to see markets having their strongest rally of the year. Hedge funds watched as most Shorted baskets in Europe traded up 15% since the start of October vs Stoxx 600 +8%. Even the 2022 winner had a horrible week last week…Systematic community had their 2nd worst daily performance ytd on thurs and I’d assume the macro community were hurt on both rates and short gbp. For me, another high velocity blip…but not much actually changed. Rich Privo put it well….”Think Waller made the position pretty clear overnight “The U.S. Federal Reserve may consider slowing the pace of rate increases at its next meeting but that should not be seen as a “softening” in its commitment to lower inflation… Markets should now pay attention to the “endpoint” of rate increases, not the pace of each move, and that endpoint is likely still “a ways off.”
So what to do from here? Back to the barbell approach if you ask me. I don’t feel like last week was the signal to re-risk but it may be the signal that we can begin to model an accurate forward fulcrum risk free rate. With that duration assets and quality secular growth become easier to price and therefor should see more balanced activity than the one way de-grossing we’ve seen thus far this year. That being said, I think certainty continues to trade at a premium and as such I’m minded to continue to own short duration in the form of well capitalised banks (many European names offering mid teens TSR’s), old economy names supported by abnormally high earnings, free cash flow conversion and equity withdrawal (mega buybacks) – especially in oils and commod complex and then the quality global megacap defensives/pharma/staples that have outperformed all year and will likely continue to do so. On to this week…where we don’t have much to focus on…oh wait….digesting last weeks 4 standard deviation market rally, results of Midterms and aftermath, G20 and Biden/Xi meeting, China covid rising vs property stimulus, crypto volatility and the UK austerity.
Liquidity. Last week I talked on liquidity and hidden leverage. The weekend news served as another reminder of the old Buffett adage “..only when the tied goes out do you discover who’s been swimming naked.” This weekends news flow acting as another reminder of the value of liquidity and the need for robust risk, liquidity and collateral frameworks for higher vol environment. As several episodes through time has proven…. there is a dramatic difference between ‘liquid’, ‘less liquid’ and ‘illiquid’. Even in the more benign space of public equities, thurs/fri saw a 9 standard deviation move in midcap momentum long/short. For me, this in part reflects the continued withdrawal of liquidity from the system. I suspect the market remains a traders environment more than an investors one in the short term.
Flows. Positioning on a gross and net basis for investors remains relatively light. Going into CPI net exposure for fundamental investors was down to the 5th percentile on a 3-year lookback. Buybacks remain a supportive tailwind for markets…..to borrow from Tony P “2021: authorizations of $1.23tr, executions of $992bn. FY’22 estimates: authorizations of $1.2tr, executions of $1.0tr (that would mark a new record). FY’23 estimates: authorizations of $965bn, executions of $869bn.” Finally, CTA asymmetry is becoming more balanced and positioning cleaner but for now still marginally skewed to buy. Systematic funds now net long $5bn of global equities or 42%ile, and set to buy $72bn over one month on up tape vs selling $85bn on a down tape. Investors have spent the last few months rotating back into US (safe haven, $ and stronger consumer), into defensive well capitalised cash flow generative names and up the market cap curve (large and mega cap).
Due diligence. I read an interesting article on the Information this weekend titled “no additional work required”. It references a now made public comment from a well know VC founder around the time of their Twitter investment. I have often stated that the era of stories and narratives is over, the heady time of 2020/21 and the abundance of capital fueling what companies ‘might be’ in the future is behind us. We already noted the engines reverse on hiring within the sector earlier. With that pragmatism more scepticism could follow…..even in the power law driven right tail world of venture capital. As I read about Crypto-land and its latest crisis and note the quality brands/investors that have been impacted, it does highlight a few things. Venture/Growth grew incredibly fast both in terms of fund launches, fund sizes, assets under management AND it deployed this new found capital extremely quickly and arguably/possibly with less process and/or discipline than what we’d normally see. The competition for access to cap tables became paramount and the size of funds may have resulted in a few things….style drift in terms of sectoral focus and expertise, due diligence holidays due to requirements of speed…too much focus on ‘who else was on the cap table’ and piggy backing of others ‘due diligence’. To put numbers to this…we saw 35k deals in 2021 and over $600bn of capital flow in to ‘start-ups’ of all sizes last year. Overall, $1.4tn found its way into growth companies globally last year. Some investors we’re close to doing a deal a day. When you reconcile that with a stat I recently read it gives cause for pause….”since 1994 there have been 1276 private equity funds focusing on growth equity…of that number only 22 have delivered on 2.3x their money.” To be fair, this was not specific to venture and growth, it was true in public markets. Companies with $1m of ARR hitting $100bn market caps based on growth and TAMs. In reality everyone became a growth investor in 20/21 to a greater or lesser degree and so this is not cohort specific….and as a result everyone got burned to some degree. End of day….growth investing is hard…when it works it is extremely profitable, especially in the age of innovation we find ourselves in…that being said…process over outcome…always.