Taking stock of equities

"The monthly candle looks to be delivering a classic reversal signal, with prices rejecting the move below $40 in the strongest possible way. "   Ermmm....OK.   Someone forgot to tell the oil market that the monthly candle was so constructive, because yesterday's price action managed to eradicate all of Monday's stunning gains.   Perhaps oil traders are all actually physicists wishing to demonstrate Newton's third law of motion, e.g. that for every action there is an equal and opposite reaction.

Of course oil was just one of the storylines in what was a pretty ugly day for equity markets.   As a number of readers have pointed out, the failure of the VIX curve to disinvert during the rally was something of a canary in a coal mine; as anyone who's ever built a VIX trading model can tell you, the shape of the volatility curve is the most powerful signal that the vol market can give.

It's been mentioned before, both here and elsewhere, that price action such as that which we've observed is a function of the market incentive structure that's been in place over the past few years of rising equities and low/declining volatility.  It was too easy to make money clipping coupons/selling vol/playing tight ranges; that your author is blogging rather than trading a book professionally is testament enough to how the market viewed those with the temerity to try and run a long vol profile in 2012-14.

In any event, the analogue industry has been doing a roaring trade over the past couple of weeks, pumping out a seemingly never-ending series of  "x is at its y-est point since 2008" type comments.  It is certainly the case that for certain emerging markets and commodity producers, the current environment is substantially worse than in 2008, thanks to the structural and cyclical deceleration of China, lots of new commodity supply having come online in the last 7 years, etc.

It's worth reiterating, however, that for the G3 things aren't remotely as bad as they were then.  Japan at least has a tailwind of financial market dynamism thanks to Abenomics;  in Europe, there's the pragmatic Draghi rather than the trigger-happy Trichet in charge of the ECB, and in the US the slow steady plod continues without a housing market collapse.

It's worth noting that during the last equity peak, SPX earnings estimates were already declining steadily for a year before Lehman went bust and the world as we knew it ended.  There was certainly a hint of that earlier this year as the crash in oil caused widespread markdowns of energy earnings, but since then estimates have tracked steadily higher (albeit not quite yet to the peak.)

Lest anyone accuse Macro Man of naively swallowing whatever swill equity analysts spoon towards him, allow him to acknowledge that only a fool takes the consensus estimates at face value.  Markets, however, are ultimately priced on expectations, and his research over more than a decade indicates that consensus earnings estimates are a useful barometer for predicting medium-term equity performance.

Given the apparently divergent fortunes of sundry regions around the world, Macro Man thought it would be useful to break out a piece of work he did 15 months ago but hadn't looked at since he lost his Bloomberg subscription last August.  It's essentially a global equity scorecard, ranking a number of MSCI indices on a total of nine fundamental and technical factors.  Each index is ranked for each factor from 1 (the best) on down, and the scores are then summed to get an overall rating (with the lowest obviously the best.)

The full-cohort ratings are set out in the table below.

Macro Man was gratified to see that China, which ranked close to the top when he last ran the analysis last August, is now closer to the bottom....along with a whole host of other EM markets.  Interestingly, the US ranks as the worst of the developed markets despite outperforming most other markets on a price basis during the downturn.

Similarly, it is intriguing to observe that the top rankings are populated more or less exclusively by European equities; clearly this approach believes that they offer value vis-a-vis the rest of the world.   Please note, however, that this type of analysis makes no attempt to determine whether these indices will outperform cash.

The same holds true if we just look at the developed-market countries; the top is exclusively populated buy Europeans while the US is part of the bottom tier with Canada, the UK, and two large multi-country indices.

As for EM, didja ever think you'd see Turkey at the top?  Clearly, the analysis is focusing on local currency, rather than USD, returns.  Still, the dichotomy with fellow FX whipping-boy Brazil couldn't be more stark.

While the analysis is of course not fail-safe, it may give readers something to chew on as the correction matures and people look for bargains to buy.  Clearly, not all markets (developed or emerging) are created equal, and it's interesting to note places like Europe where this approach at least thinks that the sell-off has created a decent pocket of relative value.

There will be no commentary tomorrow as Macro Man is heading to Vermont for some cycling in the hills.  He'll be back in time for payrolls.