1) Stock market could be on the verge of a “lost decade” for investors, says Ray Dalio
The InvestQuest’s View: There’s a chart from Bloomberg that suggests annualized S&P 500 returns for the next ten years will be in the zero-to-low single digit percentages, given the elevated level of investors’ equity allocation now. I would cautious on being too overweight on stocks.
2) Goldman Sachs sees investor equity allocation as elevated, with limited scope for further increase
See Point 1 and 3 for our view.
3) JP Morgan expects up to $170bn in institutional net selling of stocks in the next two weeks
The InvestQuest’s View: Bridgewater and Goldman Sachs had looked at longer term equity allocations to express conservatism on stocks. However, JPM’s update has a more immediate market impact, so I would likely trim some stocks near term and try to reposition back if a market dip truly materializes.
4) China to step up US agriculture purchases after “secretive” Hawaii talks
The InvestQuest’s View: While the relationship is fragile, we have been seeing some positive developments on the US-China front including the news above. With valuations of Chinese stocks much more reasonable, it makes sense to trim US stock overweights and diversify into China stocks.
5) US banks’ stress test results to be published on 25 June (Thurs)
The InvestQuest’s View: Any news of dividend suspensions (similar to what the European / UK regulators did earlier) or forced capital raisings will likely shake investor confidence. Might be wise to avoid the US banking stocks till the Comprehensive Capital
Analysis and Review (CCAR) results are out.
1) Stock market could be on the verge of a “lost decade” for investors, says Ray Dalio
Note: Ray Dalio is the Founder of Bridgewater, the largest hedge fund in the world.
Ray Dalio’s Bridgewater Associates said in a note on Tuesday that the stock market could be on the verge of a “lost decade” for investors, Bloomberg reported on Thursday.
A “lost decade” for stocks would reverse a years-long trend of strong growth for corporate earnings as globalization has already peaked, Bridgewater said.
Note: The Lost Decade is a term initially coined to refer to the decade-long economic crisis in Japan during the 1990s.
The InvestQuest’s View: I saw an interesting chart from Bloomberg recently (chart below) that made reference to the above news. The data showed a very high correlation between investor equity allocation and future 10-year returns (chart below). Given the elevated level of investors’ equity allocation now, it suggests that annualized S&P 500 returns for the next ten years will be in the zero-to-low single digit percentages. Hence, I would cautious on being too overweight on stocks.
2) Goldman Sachs sees investor equity allocation as elevated, with limited scope for further increase
Already elevated equity allocation and policy uncertainties should taper stock buying demand. In Goldman Sach’s US Weekly Kickstart publication released 19 June, Goldman estimated that aggregate investor equity allocation has rebounded back to 44% (80th percentile since 1990, chart below) and the actual figure could already be even higher, factoring in the recent jump in retail investor activity.
“We expect the potential risk of a viral “second wave” and the fast-approaching US presidential election will limit a significant increase in equity exposures in the near term. Plummeting buybacks and record issuance will drive a 80% drop in net corporate equity demand. We expect pension funds and active mutual funds will remain net sellers.”
3) JP Morgan expects up to $170bn in institutional net selling of stocks in the next two weeks
Extracted from JPM’s Flows & Liquidity weekly publication for 19 June.
“Not only has the continuation of the equity market rally into June naturally eroded all of the previously estimated positive equity rebalancing flow, but it has likely created a need for negative rebalancing flow, i.e. equity selling, of around $170bn on our estimates into the current month/quarter end.”
Do note that the $170bn mentioned is an upper limit to JPM’s net selling estimate for institutional investors that have either fixed allocation targets or tend to exhibit strong mean reversion in their asset allocation.
As a result, JPM sees a risk of a small market correction in the upcoming two weeks but continues to believe that we are still in a bull market and any dip would represent a buying opportunity.
The InvestQuest’s View: Bridgewater and Goldman Sachs had looked at longer term equity allocations to express conservatism on stocks. However, JPM’s update has a more immediate market impact, so I would likely trim some stocks near term and try to reposition back if a market dip truly materializes.
4) China to step up US agriculture purchases after “secretive” Hawaii talks
On Thursday, US Secretary of State Michael Pompeo said China’s top foreign policy official (CCP Politburo member Yang Jiechi) committed to honour all of his nation’s commitments under the trade deal. This came after their “secretive” meeting at Hickam Air Force Base in Hawaii on Wednesday.
China pledged to buy US$36.5 billion worth of American agriculture products under the phase one deal, up from US$24 billion in 2017, before the trade war. However, China bought only US$4.65 billion in the first four months of the year, data from the US Department of Agriculture (USDA) showed. That is only 13 per cent of the goal set in the trade deal and almost 40 per cent below the same period in 2017.
The InvestQuest’s View: While the relationship is fragile, we have been seeing some positive developments on the US-China front. Prior to this, China made an active decision not to retaliate on further restrictions placed on Huawei in mid-May and earlier this week, the US Department of Commerce clarified that US firms may work with Huawei on setting 5G standards. With valuations of Chinese stocks much more reasonable, it makes sense to trim US stock overweights and diversify into China stocks.
On the other hand, a SCMP article published today titled “China-US tensions could be worse than the Cold War, academic says” was less optimistic.
5) US banks’ stress test results to be published on 25 June (Thurs)
The U.S. Federal Reserve is incorporating three different recovery scenarios related to COVID-19 into this year’s CCAR (Comprehensive Capital Analysis and Review) stress tests for large banks amid “unprecedented uncertainty” about the virus and the economy, a senior Fed official said Friday.
Results of the stress test will be released on 25 June (Thursday), which will likely have an implication on US banks’ future dividend and share buyback policies.
The InvestQuest’s View: Any news of dividend suspensions (similar to what the European / UK regulators did earlier) or forced capital raisings will likely shake investor confidence. Might be wise to avoid the US banking stocks till the CCAR results are out.
Thanks Peter! It seems like you lean bearish. I think (a big) part of the reason we saw the strong market rally is precisely because of bearish investor positioning, so even if we were to get a pullback now given more moderate positioning, we may not get a large pullback given strong fiscal/monetary stimulus. I also don’t know if growth (i.e. FANG) will pullback or the value/cyclicals, given the first time around we had a strong value snapback, though the gap between the two is very wide.
It’s interesting on Dalio – he has been a permabear on the cycle, however I don’t think he is overweight liquidity (i.e. cash). I think he would offer Ag as the alternative – what would you do if you are pulling back on equities?
Hi Joel, glad to hear from you.
I’m definitely more of a bear at this point but I’m also not expecting to see the same extent of a pullback in the event of a second market dip, given the reasons that you mentioned.
My main concern is that the market is underpricing the impact of potential US tax hikes next year, resulting in actual forward P/E levels for US equities being materially higher than the 21-22x currently depicted. My second concern is on the leverage overhang even as the market starts to recover. Assuming economic activity picks back up to pre-Covid levels by next year, many corporates would have taken on more debt this year to bolster liquidity levels, so net margins next year might possibly still be materially lower than 2019 (not to mention any write-offs on receivables if counterparties go belly up in the year ahead).
Personally, I like both XAG and XAU. XAG is undervalued on a historical XAU/XAG cross basis but I doubt that XAU/XAG will revert back to the 70s level anytime soon, given that XAG is much more correlated to economic activity (believe half of XAG demand comes from industrial use).
Since I assume that 2021 EPS growth is not going to be able to compensate for the 2020 EPS decline and valuation multiples are already fair (with investor position already slightly above average), the c.zero EPS growth and c.zero multiple expansion would indicate zero expected returns till 2021 from current levels. In this environment, I would favour being a seller of equity volatility (by selling OTM equity put options) whenever VIX goes above 30, to try to pick up stocks that I want at 15-20% discounts to current levels and generate some yield from the option premiums in the meantime.
For example on a broad Index, I could sell S&P 500 put options expiring end-September at 2,750 strikes to monetize 3.3% option premium now (breakeven at around 2,650 Index level), which to me has relatively decent risk-reward relative to direct equity exposure.
Do you think that is a decent strategy?