Should the pullback continue for much longer? It is the case that some
indicators are looking stretched, but…
MXWO was off 3% last week, but despite this global equities are still up 3.5% ytd, TR. It appears that the call for
a 10-15% correction is fast becoming consensus. Should one position for it? We revisit a number of tactical
indicators that we tend to follow, and the results are not that clear cut. Yes, on the negative side:
1. MXWO was as recently as a week ago heavily overbought. We didn’t experience any material weakness in
SPX for almost 2 years. Sentiment is complacent. The spread between bulls and bears in II survey is the highest
since 1986. Positioning is long, with elevated HF beta.
2. Investors are almost unanimously bullish on growth/earnings, but US CESI is rolling over and China dataflow
appears to be stalling – see page 9.
3. Valuations of Cyclicals are above 1 st. dev. expensive vs Defensives. The pricing of market internals is in
stark contrast to the start of ‘16, when Cyclicals were outright cheap and consensus view was overwhelmingly
bearish.
However, on the positive side: 1. Inflows into equites are extremely strong and this should not be seen as a
contrarian indicator. These flows will ultimately provide a floor for the market.
2. Our work suggests that equities didn’t tend to correct from the peak in CESI or in ISM. Some have been
calling for the rollover in 2nd derivative to hurt stocks for months now, without success. If CESI moves below zero,
then this would create a more clear bearish signal, with Cyclicals lagging Defensives. There is still some way to
go before we get there.
3. Bond yields breaking out are seen by many as a red flag for equities. We disagree. The cushion between
equities and bonds in relative value terms is still very significant and real rates remain outright negative.
Equities tended to shrug off sharp 50-100bp sell-offs in bonds – see page 32. Credit spreads and peripheral
spreads remain well behaved and any further move up in bond yields might bring about an asset allocation
switch.
4. Seasonals remain positive until April. Also, our work shows that strong starts to the year, such as what we
had in January, have actually resulted in above normal market performance for the remainder of the year
– see page13.