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  1. Home
  2. / Investing
  3. / Economic Data

As Usual, Equities Are the Last Ones to Get What Is Really Happening

Like central bankers, the equity markets seem oblivious to weakening global economic conditions that indicate a recession already is here.
By MALEEHA BENGALI
Sep 23, 2019 | 09:41 AM EDT

Investors always have a tendency to feel emotionally attached to their trades. As a trade moves against them, they face the perilous task of holding on to their convictions while watching their profit fall tick by tick into the red. It's a formidable task to be cerebral about one's decisions and to have the confidence and humility to say, "I think I got it wrong." Few can do so because it means admitting defeat. The ability to do so is what separates the great traders from the common masses.

Watching your profit-and-loss statement go further into the red causes yet another powerful factor to take over -- human psychology. We end up convincing ourselves that we must be right. As the old adage goes, to survive in this market, cut your losses fast but run your winners longer.

September has seen a lot of volatile moves, both on way up and down. Most of the themes that were played out in the first half of this year have unwound in the last few weeks. As the economic data grew worse and worse from region to region over the summer months, investors parked their cash by buying as many bonds as they could. The whole world started getting long of bonds, as can be witnessed by $15 trillion in global bonds yielding negative coupons. In essence, investors were investing $100 today that might yield less than $100 10 years from now, and on top of that they were willing to pay out an interest rate to the borrower -- absurd logic.

The investment corporate bond market usually trades with a positive yield given the risks inherit in investing in companies that could go bankrupt if badly managed. Today there is about $1.2 trillion in corporate bond market trading with negative yields. As usual, investors and momentum traders see a trend and chase it without knowing what is causing it or what can cause it to break the entire system -- the Great Financial Crisis (GFC) of 2008, anyone?

Over the past few weeks bonds massively u-turned and yields started rallying across the board as money came out of bonds into equities given yield differentials. The U.S. 10-year government bond yield rallied to as high as 1.8% from lows of sub 1.5% in early September.

This massive selloff in bonds caused a knee-jerk reaction in unwinding all the consensual trades of the year, namely long gold and short banks, retail and industrials, to name a few. Conversely, energy rallied as oil stocks were massively underweight in most portfolios all this year for good reason. Saudi oil infrastructure attacks made that trade worse as people saw oil rally as high as 20% one day, not realizing that any squeeze in oil price due to geopolitical supply shortages is never a healthy earnings driver for oil companies. Lo and behold the market is now more neutralized in terms of these themes. But make no mistake: There is just one trade here, long growth or play for recession. Based on your view, you will position in the above sectors accordingly.

The question on everyone's mind is whether the reversal of the past few weeks is just a reversal or the start of a new trend. Only time will tell, but one will be paid accordingly by taking a view based on all the facts at hand. Trend chasers might just get the same- day or next-day move right, but may miss out on the bigger picture.

Central banks and economists are outright useless as time and again they have failed to understand the risks their economies face but keep doing the one thing they know how to do -- print money -- and hope it works.

Mario Draghi, president of the European Central Bank, as far back as July 25 said, "We see no signs of a recession." Yet here on Monday Germany Manufacturing PMI printed at 41.4 versus expectations of 44. Even Services PMI fell to 52.5 versus expectations of 54.3; the first fall in Services in four-and-a-half years.

People keep debating whether the recession will start in 2020 or later. News flash: We are already in one.

Federal Reserve Chairman Jerome Powell claimed last week, "We see limited signs of a recession." I dare to see what numbers the U.S. economy prints for September. South Korea reported global semiconductor exports collapsed 21% year over year. But rest assure, all is well in equity land as the semiconductor index trades at all-time highs. Of course, nothing can be wrong because the Fed will keep printing.

Regardless of the Fed cutting interest rates or even considering Quantitative Easing 4, there is something wrong with the system. The repo market last week proved that alone when even the Fed injected billions of liquidity over three days, yet rates have still not settled down. In short, there are some banks that are seeing an outright shortage of dollar liquidity. How many times can the Fed keep injecting $75 billion overnight before it does not work anymore?

Once again, GFC '08 comes back to haunt us as that is where it all started. Each asset class is linked to the other and then levered hundreds of times to risky assets. When one domino goes, all can come crumbling down regardless of "fundamentals" as one can argue what the fair value was to begin with.

One wonders how we have put ourselves in the hands of these outright incompetent economists and central bankers with all their Ph.Ds and wealth of experience who keep reiterating "we don't see anything yet" only to change their tune one month later, confused as to what to do. Perhaps central banks should be run by portfolio managers or macro specialists -- at least people who have a grasp of what is happening underneath the surface rather than call it after the fact.

The S&P 500 went past its quarterly September expiration this past Friday as the market seemed pinned to 3000 due to options expiration. Now it is free to move where the wind takes it. Despite all the Fed and central bank talk, it has failed to make new highs and keeps failing at these levels. That's an omen in itself.

Global economic growth is weak, which means all cyclical assets including equities and commodities will get hit. After a rally of 10% to 20% from lows in mining and energy stocks, it seems like a compelling opportunity to initiate shorts or at least be humble enough to take profits on your longs if you were lucky enough to be in them in the first place. Better lucky than smart, as they say

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TAGS: Bonds | Economic Data | Economy | Federal Reserve | Fixed income | Interest Rates | Investing | Stocks | Treasury Bonds | Energy | Retail | Semiconductors & Semiconductor Equipment | Industrials | Europe

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