CONCLUSION: We see a similar see a similar pattern in consensus storytelling and a similarly-asymmetric price setup as we did in the previous occurrences of our being bearish at cyclical tops in the US equity market and “risky assets” broadly (1Q08, 1Q10, 1Q11, 1Q12).
Extrapolating from anecdotes out of our institutional client base, we’d be willing to bet that the phrase: “I’m bullish because everyone is bearish,” has certainly made its way around the buyside in recent weeks.
Unfortunately for US equity bulls, its conceptually impossible for the majority of investors to be positioned in a contrarian manner all at once. Moreover, is it really contrarian to be bullish from here, or is that merely what many US equity investors are telling themselves to ease the broad-based feeling of cognitive dissonance shared by many domestic stock market operators?
Net-net-net, that is once again the key debate we feel investment teams should be having internally at yet another long-term lower-high in the US equity market, which was largely perpetuated by expectations of incremental Policies to Inflate out of the Fed/ECB.
WHERE WE'VE BEEN
On MAR 29, 2012 we published a timely note titled, “DEFINING ASYMMETRY: INVESTOR COMPLACENCY AT MULTI-YEAR LOWS” where the conclusion read:
“Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. We believe this is the key market debate to focus on.”
The note, which was a precursor to our 2Q Theme “Obvious Asymmetric Risks”, isolated a critical factor within our then-bearish intermediate-term view of US equities and “risky assets” broadly – broad based investor complacency. That call ultimately proved rather prescient all the way through to our JUN 1 note titled, “SHORT COVERING OPPORTUNITY: SP500 LEVELS, REFRESHED”:
“I think it’s safe to say that consensus now agrees with Hedgeye on Growth Slowing. Now we have to deal with cleaning up their mess. Alongside immediate-term capitulation, we’re finally seeing a Short Covering Opportunity.”
-Hedgeye CEO Keith McCullough (JUN 1, 2012)
To recap the score:
- The S&P 500 dropped -8.9% from MAR 29 to JUN 1;
- The EuroStoxx 600 Index dropped -9.8% from MAR 29 to JUN 1;
- The MSCI EM Equity Index dropped -13.4% from MAR 29 to JUN 1;
- The JPMorgan EM FX Index declined -7.5% from MAR 29 to JUN 1; and
- The CRB Commodities Index dropped -12.3% from MAR 29 to JUN 1, including a -19.6% drop in Brent crude oil and a -12.7% decline in high-grade copper.
As we turn to today, we are once again approaching critical levels in the CBOE SPX Volatility Index (~15) and our own proprietary Global Macro VIX (~18-20) that have provided clean-cut sell signals for members of our team dating back to 2007. Comparing 4Q07 to today’s setup, we spot similar patterns of broad-based cognitive dissonance among US equity investors as those ahead of the largest global recession and financial crisis since the Great Depression based upon the OCT 9th concurrent bottom in the VIX (16.12)/top in the S&P 500 (1565.15).
The then-consensus view at that 4Q07 top was that the US equity market was “appropriately” discounting a continuation of then-peak earnings generation was obviously incorrect and lends credence to our view that the crowd is often most wrong at critical inflection points in domestic and/or global GROWTH/INFLATION/POLICY dynamics.
And while we are certainly aware that consensus can remain correct longer than many individual funds can remain solvent, we remain keen to get loud ahead of what we see as pending sell-offs in US equities (1Q08, 1Q10, 1Q11, 1Q12); today we see a similar see a similar pattern in consensus storytelling: 72.5% of S&P 500 companies that have reported Q2 results have beat on the bottom line, overshadowing the 58.9% of companies that have missed top line estimates and a -548bps sequential slowdown in the YoY growth rate of aggregated SPX sales to +0.5% (per Bloomberg Professional).
Needless to say, we see a similarly-asymmetric price setup as we did in those previous occurrences of broad-based cognitive dissonance. Best of luck picking your spots on the short side out there.