US equities: short-term pain, long-term gain?

0:02Patrick Coffey:Welcome back to the Barclays Brief. It's Monday the 8th of June. Markets are moving around a lot and I'm joined here today by Alex Altman who is our head of Barclays Equity Tactical Strategies. Alex, welcome to London. Sorry about the weather. Yeah, a little bit grim outside. I imagine that's a little bit how sentiment is at the moment with the market last week. Yeah. And you think the market is going to be a bit grim in the next few months, right? Because you've turned tactically bearish at the moment. Now, you've had plenty of opportunities to do that. I remember in September last year, the street was turning tactically bearish.

0:35Patrick Coffey:You stayed bullish. In March this year, during the war in Iran, we had you on the show and you were talking about why you should stay the course and be positive on US equities. equities rallied hard and markets got to all-time highs and it's now that you've turned tactically bearish why is that so it really breaks down into a big melting pot of quantitative framework that the team uses and a lot of that has been driven by the fact that cost of financing has exploded higher so obviously real yields are a lot higher that weighs on both the multiple for the equity market we can statistically prove that and also has a cost of financing considerations just more holistically which feeds into the equity supply narrative the other aspect is just euphoria retail euphoria but to a lesser degree institutional euphoria as well again we can measure all of this we can see that retail euphoria is as high in some cases even higher than what we saw in 2021 bearing in mind we were in deeply negative real yields then versus positive real yields today And then also just from an institutional framework that there isn't really any institutional bearishness left, whether it's on the AI narrative or beyond.

1:48That's not to say it's wrong. But in our experience, when we get to this level of euphoria, the forward return profile on the S &P just doesn't look that good anymore. Yeah.

1:58Patrick Coffey:OK, let's let's talk about euphoria, because the argument against this, and I'm sure you've had many clients disagreeing with your tactical shift, is, of course, that euphoria can last a lot longer than people expect. So what is it that particularly caught your eye in your framework that made you think now's the time to shift? You're absolutely right. It's definitely not a binary. It's a gradualistic accumulation of different data points. So, you know, full disclosure, our cautiousness began to bubble up about two to three weeks ago when we began to see evidence of this, whether it was from retail euphoria, whether it was from the positioning data, whether it was from the real rate dynamic, whether it was little quantitative signs.

2:39For example, one thing we look at spot vol correlation, just for the layman terms, it's an illustration that people are reaching for the upside rather than the downside through options. And again, we can measure that. So all of these began to cumulatively feed together into our framework. And we know that our framework is typically a little bit premature. It's usually two weeks early or so. And it just gave us that sort of lead time to lean into a slightly more cautious view. But euphoria was just one aspect of it.

3:09Patrick Coffey:Yeah. Talk about the retail investor, because we talked before about how retail exposure to the economy, to the stock market is rising to levels not seen before. Retail enthusiasm right now for equity exposure seems to be ramping up. And you've talked about this meteoric rise in demand for levered ETFs. How should we think about that? Yeah, levered ETFs is probably too much to unpack specifically just for this short podcast. But in summary, exchange traded funds that have levered exposure to underlying instruments historically was confined or vast majority focused upon major indices. And then along came a bunch of single name levered ETFs, which was giving investors exposure to a certain security multiple times over.

3:57And again, there's a lot of nuance about how they get that leverage and the complications around trying to match the actual performance of what the prospectus says. But the bottom line is, is that the levered ETF AUM, assets under management, have exploded over the past few years. You know, you can trade in and out of S &P as much as you want, really. But when you get into single names, it can become more problematic. And you get these potential tail wagging the dog scenarios where in order for these levered ETFs to rebalance themselves each day, they can end up driving a disproportionate amount of stock through the underlying channel.

4:32And that can in turn become a self-fulfilling prophecy where pushing stocks have gone up a lot up even more and vice versa to the downside. And I think that's basically to a degree what we've seen over the past few weeks.

4:43Patrick Coffey:Yeah. OK, so that kind of shifts the volatility dynamic on the single stock side. How should we think about the kind of bigger picture of the momentum trade here? So it's all tied to the same theme. So if you think about concentration risk, semis and AI, the zeitgeist of the market, and then levered ETFs, the explosion in levered ETFs, they're all effectively tied to momentum as well. Stuff that's gone up has become very long momentum, it's become crowded, it's captured the imagination of the retail community and the institutional community. And as a consequence of that, you end up with a very crowded set of trades and a concentrated set of trades.

5:21That is natural of a late cycle bull market or even a mid cycle bull market. And it just means that it leaves these trades vulnerable to these short and sharp corrections in the event of even small positioning adjustments or indeed small narrative shifts as well. And I think just that's essentially what we're seeing right now is a narrative and positioning shift just at the margin.

5:46Patrick Coffey:Yeah. We look at the backdrop of US macro right now because the macro backdrop is actually strengthening. You know, we've had better than expected payroll data. We've had the JOLTS data pointing to hiring demand being in a strong place. ISM manufacturing is the strongest since mid 2022. So the data is beating expectations. But we've got a new Fed chair who's just in post. How does that play into your tactical view on US equities right now? Well, so you're absolutely right. The data has been strong. And part of that data, not exclusively, but part of it has to be inevitably tied to this AI CapEx cycle.

6:24So again, it's all part of kind of the same trade. And so if you've got a bunch of hyperscalers that are spending, let's just call it from a rounded perspective, a trillion dollars a year, that's a trillion dollars spent equals a trillion dollars of revenue to a bunch of non-hyperscaler companies. and that again not exclusively but in part explains why corporate earnings growth in the u.s has beaten so robustly it also explains why we're seeing some upturn in some of the industrial surveys as a result of that again not exclusively but it's certainly contributing to it and that's the virtues of a capex cycle unfortunately those don't last forever of course and when they do turn it's usually as a function of overcapacity and so on and so forth we have to acknowledge that the fundamental backdrop of the U.S.

7:11equity market or the U.S. economy is still relatively robust. And so as a result of that, it's not a case of, oh, my gosh, we're suddenly deciding that U.S. equities or just equities are a terrible place to be putting money to work. It's more just acknowledging the fact that even in a bull market or paths higher, there can be Phillips along the way, which effectively create opportunities from a tactical perspective.

7:35Patrick Coffey:And one of those, presumably, is a new Fed chair. You've looked back at the data since, what, the 30s, thinking about that? Yes, exactly. So we went back to the 1930s and basically 100 years worth of data. And it is unfortunately a very strong statistical signal that when a new Fed chair gets put in situ, i.e. when they're actually their first day in office, and we look at the S &P forward returns, they are unequivocally quite poor. Some get off more lightly than others. And even if we remove some of the exogenous data points, for example, Greenspan, who got in situ right before the crash of 87, terrible timing.

8:12Even if we remove those, we're still looking at a mid single digit drawdown in the S &P over a forward three month time horizon.

8:19Patrick Coffey:Can we just pivot to IPO issuance? How should we think about that? Obviously, there's a very large IPO calendar this year. How do you expect that calendar to impact market dynamics as well short term? So in its simplest terms, the U.S. equity market benefits from effectively negative net issuance every year and has done for decades now. And that's a result of the phenomenal buyback activity that is prevalent in the domestic markets. And even with the expected IPO issuance this year, which could be in excess of$400 billion, that's before we consider follow-ons and lock-up expiries and whatnot, we're still going to end up with a negative net issuance of north of$200 billion.

9:04And so the IPO calendar itself is not hugely alarming. However, the timing around those issuance of the IPOs could be quite lumpy. We don't know. We just don't know what the lockups look like exactly. We don't know the timing of certain jumbo IPOs later in the year.

9:23Patrick Coffey:So yet another thing for investors to watch out for this year. OK, so if you put it all together, we've talked about cost of financing being higher, some euphoric signals in the market, some macro uncertainty with the Fed, and we've got the IPO issuance. You've put this tactical bearish call out there. How much do you think the market could fall? and what would trigger you to kind of lean back into a more bullish view? So again, we work everything within a quantitative framework or as much as we can. And we get asked this question a lot. So bearing in mind, we've already fallen by two, 300 basis points in the S &P.

9:57The framework as it outlines today, we'll be looking for, again, around a mid to high single digit pullback in US equities. Let's just call that between six and seven percent. So maybe we're halfway done. Again, nothing hugely dramatic and hugely scary at this point, absent, say, a seismic exogenous shock. But what would get me more bullish again? Well, I mean, first and foremost, price. Lower prices flush out some of the euphoria. That would be helpful. Seeing, let's just say, some of these issuance get digested well within the market and price performance being robust on the heels of that. That would be another.

10:35and I suppose the other thing just to keep in mind is real rates. I do believe that the upcoming Fed chair meeting, the first one obviously for Kevin Walsh, is absolutely important to set a tone to try and tether the cost of financing. So when real yields are this high, it is a problem ultimately for the US equities and if the Fed chair has the ability to try and jawbone those lower and provide some assurances, then I do think that would also provide the tailwind as well. So as it stands, we're not there yet. And again, price drives narrative. Having lower prices, I think, in itself will be a bit of a remedy.

11:18But absent that, we'd need to see the signs of euphoria and those real rates lower as well. Okay, brilliant.

11:24Patrick Coffey:Alex, thanks so much for joining me. It's been great to have you. Thanks again. Okay, so I think the key takeaway is that this isn't about Alti calling the end of the cycle, but it is a non-consensus tactical call recognizing that the setup has become more stretched and the balance of risks has shifted. So with rising retail euphoria, crowded momentum and ongoing Fed uncertainty, Alti's caution is driven more by the technical setup than by any wholesale change in long-term fundamentals for the US market. Thanks a lot for joining me and And as always, if you've enjoyed this episode of the Barclays Brief, please hit subscribe.

12:02Patrick Coffey:Thanks for listening and we'll see you again next week.