Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The fight between sentiment and fundamentals
Peter Garnry
Chief Investment Strategist
Summary: In today's equity update we focus on South Korea and the resurgence in new COVID-19 cases, the VIX dipping below 30 and term structure in contango suggesting that the bear market dynamics could soon end, Brazilian equity market trading a deep discount to global equities and finally that the market for fundamentals is still reluctant to jump on the bandwagon of optimism as seen in US technology stocks.
Equities are generally positive this morning as the market is still pricing in a V-shape recovery putting little weight on last week’s dire macro figures ending the week with the US unemployment rate hitting 14.7% in April. We are technically positive on the market as long as the NASDAQ 100 Index remains above its 15-day SMA but we still struggle to be positive on equities based on fundamentals. What are some of the key things to watch in equities today?
KOSPI 200 down 0.6% - number of COVID-19 cases have recently surged and today saw 34 new cases the highest since 9 April as new chains of the virus has started at nightclubs in Seoul. This comes after Germany just announced that its R0 (virus reproduction value) increased to 1.1 as it opened up society. These stories tell us that reopening the economies may not be that easy and LesEchos has in collaboration with Kayrros-EY Consulting made a new real-time economic activity index based on satellite images. This shows that Chinese activity despite reopening is still down 25% from levels before the COVID-19 outbreak.
VIX dips below 30 – on Friday the VIX Index dipped below 30 for the first time since late February in a signal that option markets are betting on less volatility the next 30 days. The VIX futures term structure has also shifted into the classic contango which should begin to favour selling volatility strategies. This means that the market is structurally beginning to set itself up for normality. The equilibrium point in VIX is historically around 22 so if the index dips below this we are officially out of the bear market dynamics.
Brazilian equities down 51% from peak – while many equity markets have recovered somewhat the Brazilian equity market is still down significantly from the peak in USD terms. Sentiment is obviously bad due to a gross mismanagement of the COVID-19 outbreak by the government but with Brazilian equities valued at a 55% discount to global equities it may be worth making a bet on this EM market. Given the uncertainty over EM markets and the rebound one should consider placing the bet with call options on the main index or an ETF tracking the equity market.
Dividend futures are flat – fundamentals are traded in dividend futures in both the US and Europe and here we still observe little price action to the upside. Compared to a month ago the curve for the S&P 500 has not moved much except for a little higher in 2020 and 2021 but still at same levels further out the curve. In other words the market for fundamentals are not following the speculative fever we observe in US technology stocks. S&P 500 is valued almost 20% above the median valuation point of the expected distribution for 2021 dividends in the S&P 500.
Last week US technology stocks increased their share of the US equity market even further pushing the index concentration closer to an all-time high. Online and technology stocks are perceived as a sure bet fueling the rally but it reminds us of the Nifty Fifty period in the US back in the 1960s/70s when a group of 50 growth stocks were perceived as sure winners sporting very high valuations relative to the rest of the equity market. Growth could not live up to expectations and these 50 stocks caused a prolonged hangover for the US equity market. Could it happen again?
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