LD Macro Weekly Report (June 19, 2023): Market Sentiment Improving, Global Rebalancing Underway

Summary

l The rebound led by AI is gradually evolving into a more stable optimistic sentiment. Market breadth is improving, with more stocks participating in the rise. Simultaneously, stable inflation data and the active portfolio rebalancing by investors will continue to support the stock market in the short term.

l The cryptocurrency market plummeted last week after the FOMC significantly raised its interest rate endpoint by 50bp, but sentiment improved after Friday, recovering most of the losses. The overall correlation with the stock market further declined. This week, numerous speeches by Fed officials, including Powell’s testimony, will allow the market to more accurately price the 50bp hike.

The Market Performance

Benefiting from the Federal Reserve’s decision to pause rate hikes and data showing increases in consumer confidence and spending in the United States, the S&P 500 index rose for the fifth consecutive week last week. This marks the longest weekly rally since the fall of 2021 when the Fed had not yet started raising interest rates. The tech-heavy Nasdaq Composite Index rose for the eighth consecutive week, marking the longest weekly rally since the start of 2019.

Most sectors in US stocks rose last week. The worst-performing sector was the health services, which fell 2.85%. The best-performing remained the durable goods sector, up by 5.28%. The technology sector regained momentum:

In the interest rate market last week, ultra-short-term yields for 1–3 Month fell slightly, while 2-year yields rose (mainly due to the FOMC raising its end-year interest rate expectation by 50bp). Meanwhile, 30-year and 10-year yields were largely flat:

In other markets, Japanese stocks, Hong Kong stocks, Chinese stocks, copper, and crude oil rose, while the US dollar index and gold declined. After the FOMC’s hawkish pause, cryptocurrencies temporarily plummeted but mostly recovered their losses after Friday:

The 60-day rolling correlation between cryptocurrencies and the stock market continued to decrease, hitting its lowest level since July 2021:

Capital Flows, Positions and Sentiment

International capital flows from EPFR

According to EPFR data, for the week ending June 14, global fund flows can be summarised as follows: US stocks, particularly tech stocks, saw a significant inflow. Chinese and Japanese stock markets also experienced inflows, while European stocks

experienced outflows. Meanwhile, money market funds faced outflows, and bonds saw inflows:

l Both equities and fixed income funds experienced net inflows, with the net inflow to global equity funds increasing to $22 billion, up from the previous $8 billion.

l This net inflow is primarily due to demand for US equities, especially the massive inflow to US tech industry funds. However, Western European equity funds continued to see outflows, while inflows to Japanese equity funds increased.

l In emerging markets, Mainland China equity funds received net inflows, while outflows from South Korean equity funds deepened. At the sector level, inflows to tech funds remained high, especially compared to other cyclical industry funds (such as energy).

l Notably, money market fund assets decreased by $38 billion, marking the first net outflow in eight weeks.

Deutsche Bank’s integrated position data

According to Deutsche Bank’s summary, U.S. equity position allocations last week increased further, moving into the overweight area (z Score 0.38, at the 64th percentile historically),marking the highest level since January 2022.Given the lag in data and the optimism in market sentiment over the past two weeks, the actual current positions may be even higher. Both discretionary and institutional investors’ positions have jumped, with discretionary leading the rise in positions over the past two weeks.

As can be seen from the graph below, so-called systematic investors (funds with a systematic investment strategy, mainly institutional investors) began to increase their holdings as early as March of this year, but the past two weeks have been driven by discretionary investors (subjective investors, who are easily influenced by sentiment, which can be understood as representing retail investors’ positions). A similar scenario of institutions increasing positions first, followed by discretionary strategies, can be traced back to 2019, with both resonating from mid-year until the advent of COVID-19 in early 2020.

It is evident that from last year to the end of May this year, discretionary investors have consistently maintained a low allocation. With interest rate hikes, liquidity withdrawal, and slowing economic momentum, new pessimistic views continually emerge in the market. However, as time passed, instead of selling off, the stock market rebounded steadily. Then, last week, discretionary investors finally switched from under-allocation to over-allocation. At the same time, the market finally broke away from large tech stocks and experienced a broad rally. Last week, they further increased their positions, reaching the highest level since April 2022.

In comparison to historical data, the current position level of discretionary investors is at the 54th percentile, which is neutral. The institutional position is higher, at the 74th percentile, which is slightly high. The combined position index is at the 64th percentile, indicating a slightly high neutral level. This shows that the current position is not extreme and there is room for further growth.

The evolution of positions this year bears similarities to 2019. At the start of 2019, as volatility declined from extremely high levels, institutional investors were the first to increase their risk exposure, driving the market up. Discretionary investors, however, used this rebound to reduce their risk exposure, transitioning to underweight stocks. Just like today, there were many concerns at the time, such as the trade war, inverted yield curves, soft data from the US and China, and capital concentrated in large tech companies.

By early October 2019, discretionary investors were still significantly underweight, even though institutions had increased their risk exposure to the overweight area. However, as the stock market continued to stabilize, discretionary investors began to significantly increase their positions, switching to overweight even before any rebound in growth indicators. This drove the strong rebound in the last quarter of 2019, which lasted until the outbreak of the pandemic in 2020.

CFTC Futures Data

Last week, the net long positions in U.S. stock futures further increased to the highest level since the end of last year.

Among them, the S&P 500, which represents large blue chips, had the most significant increase in net long positions. The Nasdaq 100, representing tech stocks, saw a slight decline, while the Russell 2000, representing small-cap stocks, turned net short:

Investor Sentiment Indicators

The AAII Investor Sentiment Indicator continues to turn positive, with the proportion of bearish participants slightly declining and the bullish ratio slightly increasing to the highest level since November 2021:

CNN’s Fear & Greed Index has refreshed the historical high set in February this year, maintaining extreme greed levels (75 or above is extreme greed) since June 6:

Goldman Sachs’ position sentiment indicator has risen significantly, now entering the level of excessive overweight:

Bank of America’s Bull-Bear Indicator slightly rose last week, remaining in a positive but not extreme range:

Goldman Sachs’ Prime Book Data

Hedge funds were heavily invested in large tech stocks at the beginning of the year, but by June, they increased their short positions, and net inflows began to stagnate. MAGMA — Microsoft (MSFT), Apple (AAPL), Google (GOOG), Meta (META), Amazon (AMZN) — now constitute about 15.2% of the net exposure to U.S. individual stocks on the Prime book, although it’s slightly down from the previous week’s 16.7%, and the peak in March 2020 was about 18%. MAGMA’s position in Goldman Sachs’ PB statistics also began to decline.

In addition, defensive sectors (including consumer goods, healthcare, and utilities) were heavily sold off last week, with healthcare stocks experiencing net sales for the first time in the past nine weeks:

Defensive stocks usually perform robustly in a downturn because people need the products and services these industries provide, regardless of the economic situation. The withdrawal of funds from this sector may indicate a current shift towards an optimistic outlook on the overall macroeconomic backdrop.

Our Comments

The rebound of small-cap stocks and value stocks (those with reasonably estimated cash flows and not high valuation multiples) has finally started to show a leading trend. Whether to continue to switch positions or to stick with tech stocks is the recent focal issue.

The recent market rally may be due to a large number of previously short positions starting to surrender and close, pushing the market up. However, it does not mean that the market is entering a new cycle, and the leading position of tech stocks is unlikely to end in the short term (or at least before inflation accelerates again), mainly because U.S. economic growth is not strong.

Although the risk of a U.S. recession is declining, the current and short-term U.S. economic growth rate is just between a moderate level of 0%-3%. To achieve a U.S. growth of more than 3% requires the push of technological innovation. During this period, it may be difficult for value stocks and small-cap stocks to truly attract a large allocation of funds. In addition, the decline in inflation is beneficial to tech stocks. During periods of low inflation, stocks usually associated with tech stocks perform better. Also, despite the continuous expansion of tech stock valuations, considering the high growth brought about by themes such as AI and robotics, the current valuation is not exaggerated, and it’s hard for funds to find exciting investment hotspots in other themes.

Of course, the premise is that the economy continues to grow moderately without a systemic crisis. If a credit crisis re-emerges or inflation accelerates again, value stocks or defensive stocks may outperform.

In the crypto market, MakerDao has raised the Dai deposit (DSR) interest rate to 3.49%, which is already higher than the yield of U.S. tax-free money market funds (about 3.2%), although it is less than the generally 4.2%~5.1% yield of taxed money market funds.

This is a very clever move. Previously, some blockchain projects wanted to bring the risk-free income subsidized by the Federal Reserve to the blockchain, which required the establishment of a private fund structure, with strict KYC requirements for investors and a minimum buy-in threshold of $100,000. However, Maker uses the method of taking user’s USDC for off-chain financing, and the interest earned is subsidized to DAI holders through DSR, which indirectly forms a product similar to a money market fund. The most important thing is that there is no KYC and no minimum buy-in threshold. This solves the problem of how to obtain real-world risk-free returns in the crypto industry, which in theory can change the existing industry structure.

In addition, some people may worry that this can be considered as an “interest rate hike” in the coin circle, which may affect the liquidity of the market? We believe this is an overconcern. Because DAI is a product of over-collateralization and leveraging, and it is not the main stablecoin used in the market, the return of DAI to DSR collateral has a limited impact on market liquidity. Some idle USDC or USDT may be exchanged for DAI for financing, which is a significant advantage for the MakerDao project.

Lookout for the Following Week

This week, Fed Chairman Powell will appear in Congress to attend the semi-annual monetary policy report hearing. At that time, congressmen may challenge Powell on why the Fed believes it still needs to raise interest rates by another 50 basis points to address inflation, and the risk of further interest rate hikes leading to higher unemployment.

With the end of the Fed’s June policy meeting, several officials will give routine speeches, including Fed Governors Waller and Bowman, New York Fed President Williams, and St. Louis Fed President Bullard. It is worth paying attention to the latest statements on policy stance within the Fed.

Monday: U.S. June holidays (stocks, bonds, futures all closed), market liquidity is expected to be poor

Tuesday: Minutes of Reserve Bank of Australia meeting, announcement of the National Bank of Hungary, Germany’s May PPI, U.S. May building permits

Wednesday: Minutes of the Bank of Canada meeting, UK’s May CPI, Powell’s House of Representatives hearing

Thursday: Bank of England announcement, Swiss National Bank announcement, Norwegian Central Bank announcement, Turkish Central Bank announcement, Mexican Central Bank announcement, Indonesian Central Bank announcement, Powell’s Senate hearing

Friday: Japan’s May CPI, UK’s May retail sales, Manufacturing PMI for the Eurozone/UK/US in June.

LD Capital is a leading crypto fund who is active in primary and secondary markets, whose sub-funds include dedicated eco fund, FoF, hedge fund and Meta Fund.

LD Capital has a professional global team with deep industrial resources, and focus on develivering superior post-investment services to enhance project value growth, and specializes in long-term value and ecosystem investment.

LD Capital has successively discovered and invested more than 300 companies in Infra/Protocol/Dapp/Privacy/Metaverse/Layer2/DeFi/DAO/GameFi fields since 2016.

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