December 9, 2021

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A tiny sniff of fear

Capital markets updates

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Good morning. Markets have been looking forward to today’s (virtual) Jackson Hole confab for months — but now the consensus seems to be that we won’t get much news, after all. Too much uncertainty about the Delta variant, and too much disagreement within the Federal Open Market Committee, for Jay Powell to finally pull the trigger on tapering. But whatever happens, the pressure on him will not abate. Just yesterday, Korea announced a rate increase — the first developed economy to do so. And TSMC, the biggest chipmaker in the world, is raising prices by 10-20 per cent. Clock’s ticking, Jay. Any thoughts, email me at: robert.armstrong@ft.com

Do I smell . . . caution?

Is that autumn in the air, or is it a little hint of fear? My excellent colleagues on the FT’s US markets team have written a good piece about leverage coming out of the equities market. It might lean you towards fear. Margin leverage is still high, but it has fallen (just a smidgen, mind) for the first time since last spring:

Hedge funds are gently reducing risk, too. Many of them have suffered as Alibaba, a popular stock, has been taken to the woodshed by Chinese regulators. Here is their market exposure:

On Wednesday, the FT reported that David Giroux, who runs T Rowe Price’s Capital Appreciation fund, has trimmed his equity exposures, from about three-quarters of his fund at last year’s lows to something over half now (the fund managed more than $50bn in assets as of late last year according to Morningstar). “Giroux has established a record of being judicious about the equity market cycle, raising and cutting exposure at key moments,” Michael Mackenzie writes. 

During the past few months, the outperformance of defensive sectors has been pretty consistent, too. Utilities, healthcare and the “growth when nothing else is growth” Faang stocks have outperformed financials, industrials and particularly energy (financials have received a little help from rising Treasury yields in the past few days): 

The chill hand of caution has touched bonds too. High yield spreads are creeping gently up. Here is a fine chart from Capital Economics, showing the increase in spreads for different sectors of the high-yield bond universe:

Now, energy spreads blowing out has a lot to do with oil prices. Take those out and spreads on the rest of the high yield and investment grade indices look like this:

Options market observers see a rise in risk aversion, too. Garrett DeSimone, head of quantitative research at OptionMetrics, pointed out to me that the term structure of the volatility futures market is particularly steep at the moment.

In other words, if you want to hedge market risk using options on the Vix index, it is unusually expensive to use the futures for (say) seven months out relative to four months out. Traders are looking into early 2022 and seeing the potential for turbulence, and they are paying up for protection. 

So, a little shiver is passing through markets. The causes are probably some combination of imminent tapering, mixed signals from the Chinese economy, and Delta spreading in the US — the same trends that might make Mr Powell, once again, kick the can down the road in his speech today. 

Better buyback data

I have been hemming and hawing about the effect of stock buybacks on the markets this week, wondering where the right data on this might be. I should have known to go straight to the US national accounts (I looked at this data years ago and forgot about it; I am old). Here from the “flows” data is net purchases and sales of equity liabilities by non-financial corporations (that is, buybacks) going back 40 years. Note the values are inverted, so the line rises with net corporate purchases of equities (and therefore reductions in the liability):

Corporates have been big net buyers of their own equity, to the tune of about $350bn a quarter, on average, for at least 15 years. This is very important because the situation is different for US households:

Households are net buyers over the past 15 years, on average, but at a much smaller scale than corporations: about $50bn a quarter, on average (directly and through mutual funds, pension plans, insurance policies and so on).

If you think, along with Gabaix and Koijen, that flows (carefully defined) are important to share prices, then you can only conclude that buybacks are an important reason for the market’s rise. 

A final world on ESG

This email came from a person who runs ESG investments at a global asset manager you have heard of:

I moved into an ESG focused role a few years ago . . . and even I am aghast at the current trend. The market seems to have lost its collective mind, failing to maintain any realistic connection to what makes sense and what doesn’t. I’ve often thought about how to stand up and say ‘hang on a second’, but in my role the risk of being ostracised is pretty uncomfortable. 

That speaks for itself. And it was not the only note like this I received.

One good read

Somehow I missed this story when it came out. Palantir, a data analytics company, has found a new marketing plan: buy gold to make people think you have insight into global risk. “You have to be prepared for a future with more black swan events,” said the chief operating officer, wheeling out the weariest cliché in the forecasting racket. Well, it’s comedy gold, anyway.

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