GS Tony Pasquariello - markets and macro - FICC and Equities - March 23pdf
GS Tony Pasquariello - markets and macro - FICC and Equities - March 23pdf
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  1. markets / macro: FICC and Equities | 23 March 2024 | 12:20PM UTCwhen you have a little distance from the screens and take stock of the structural themes that are driving asset markets -- AI, cloud, biotech, GLP-1, onshoring, defense, power, Japan, India --it’s striking how rich the opportunity set has been.while there’s always something to do somewhere in the markets, I’ve been around long enough to know the game is not always this exciting and actionable; said another way: “muddle through” or “secular stagnation,” this certainly is NOT.here’s another way to frame things: if you were told in early January that three of the Magnificent Seven stocks would trade lower in Q1 ... that registered equity supply would rise to the highest level since late 2021 ... that core inflation would surprise to the upside for two consecutive months ... and, in turn, the number of implied Fed cuts for 2024 would be halved ... would you have guessed that US equities would do nothing but melt higher?the bigger picture is this: the most important stock markets in the world made higher (all-time) highs this week ... while that is a guarantee of nothing on the forward, there’s clearly no shortage of things to do right now ... and for that, global stock operators are very fortunate.the smaller picture is this: S&P rallied 2.29% this week, good for the single best week of the year, on a combination of two very powerful forces -- dovish central banks and a continued broadening of the AI narrative.what follows from here are some questions that I was thinking about headed into spring break, with a set of short-form answers.as always, fire away if you want to drill down further.///1. what was the key takeaway from the FOMC meeting? despite a forecast that runs a bit hotter-for-longer, the Fed is sticking by what they wrote down in December: three cuts in 2024 (and a presumed moderation of QT). as David Mericle argues, Mr. Powell was not daunted by the January/February inflation data, which arguably lowers the bar for a move come June: link. again, I continue to find it notable that S&P is now 450 handles higher than it was when the market discounted nearly seven cuts back in early January.2. what’s the game plan now? the GS call remains for three cuts this year, starting in June, predicated on the expectation that core PCE inflation will resume a downward trend (the Fed seems to be making the same bet). to be clear, while the recent data set has seen a plateau northof target --sparking calls for a “last mile” challenge -- our team has core PCE falling to 2.4% y/y by year-end. the pace of cuts is quarterly following June, with another four in 2025 and one-for-the-road in 2026. this would complete the easing cycle at 3.25-3.50% (which, for what it’s worth, is 100 bps higher than the peak of the hiking cycle that concluded in 2018). again, new normal, we bid adieu.
  2. 3. how significant is the upcoming ramp in UST issuance? with credit to Praveen Korapaty, our projections for net coupon supply --specifically that non-Fed investors have to absorb --are as follows: $358bn (Q1), $504bn (Q2), $546bn (Q3) and $466bn (Q4). so, there is indeed a significant step-up come Q2, which I think warrants close monitoring (particularly as the US election moves closer into view). taken together with the prior paragraphs, I wouldn’t fight a bias towards a steeper UST curve.4. did interest rate impingement continue?early in the week, as US 10-year real rates pushed the 2% level, the most duration sensitive parts of the equity market were under the hammer (witness the basket of non-profitable tech stocks, ticker GSXUNPTC). post-FOMC, this dynamic completely flipped, with an outperformance of the laggards. I presume this cat-and-mouse game will be with us for a good while longer, and I continue to be wary of lower quality names (including small cap, while acknowledging a better run of late).5. did the BOJ really pull the trigger?yes. they did what they needed to do: no more NIRP, no more YCC, no more ETFs. the market took it as a dovish hike, which has to be considered a win for Mr. Ueda given the starting point of his tenure. to be sure, this marks the exit from eight years of an epic policy experiment --as the BOJ put it, “large scale monetary easing measures have fulfilled their roles” --yet not necessarily the start of a material tightening cycle.6. what are the implication for Japanese equities? given the BOJ will continue to buy loads of JGBs, and given a structure of real interest rates that is still meaningfully negative, I think Japanese stocks will continue to do very well. with implied volatility having come off following the meeting -- and now trading below realized -- I would stick with the strategy of grabbing upside calls when the market gives them to you. finally, note that April and May seasonals are typically favorable for Japanese equities. 7. aside from the Fed and the BOJ, did anything else stick out from the other central bank meetings? the SNB surprised expectations with a cut, positioning them as the first major central bank to go. the BOE was dovish and laid the groundwork for cuts. Mexico also eased along the way. again, in the context of having a bit of distance from the screens, observations like this are cause for contemplation (emphasis mine): “most major central banks, including the Fed, are set to embark on the most synchronized loosening cycle since 2008” (Bloomberg).8. what was the impact of NVDA’s developer event?there were some elements of travel-and-arrive, with the stock doing little immediately afterwards, yet it finished higher for the 11thconsecutive week. given the setup and the move since October, that’s a fine outcome to my eye, and there was certainly nothing to dent the broader narrative here. in turn, GS ticked higher our 12-month price target to 1,000, with this as the key view (link): “all in, we come away from the keynote with a renewed appreciation of Nvidia’s 1) unique ability to innovate at data center scale (as opposed to at the GPU or chip level), 2) large eco-system and breadth of its customer and partner engagements and, 3) ultimately, compelling position as one of the key enablers and beneficiaries of the ongoing build-out of Generative AI infrastructure.” 9. set against that,are some big companies now talking down the near-term impact of AI? here’s an independent take from Jim Covello, who grew up as a semis analyst and now runs research for us:while the AI infrastructure build is clearly alive and well (with investment opportunities that are now extending to the power grid), it is notable that several large AI players, including Microsoft
  3. and Google, seem to be making a concerted effort to manage near-term expectations about what AI is capable of today. Microsoft in particular seems to be focused on making sure the Street doesn’t get carried away with the current utility of its co-pilot offering. eventually, there will need to be AI applications that replace meaningful high value workloads in order for AI to fulfill its promise. some of the biggest and best positioned tech companies are doing their best to make sure the Street understands that it may be a bit ahead of itself on how far along the industry really is on having those applications ready. this isn’t lost on investors -- to quote Pete Callahan: “amidst an ongoing debate re: the long-term ‘impacts’ of A.I. on software, investors continue to be more comfortable expressing an A.I. view down the stack (basically anything ‘hard-tech / infra’ related where it doesn’t matter ‘who wins’ up the stack).”10. did retail demand for US equity funds continue to surge? no. recall last week saw a 2.0 standard deviation upside move in the GS sentiment indicator, reaching the highest level since early 2021, driven by the largest weekly inflow on record to US equity mutual funds and ETFs. on the follow, those inflows gave way to $22bn of outflows (link).11. did equity supply keep coming? yes. when you sum up IPOs, follow ons, blocks and converts, a lot of paper hit the market this week (at least $9bn of registered issuance). that takes us to $50bn in Q1, which is the most since Q4’21 (thanks Kyle Krutis for the data). if you take this point together with the prior one, it’s notable that the market traded so well this week given tricky supply/demand technicals.12. did demand for financials continue? yes, albeit smaller than the prior two weeks, when US financials was the most bought sector (some of which came at the expense of tech names). away from cyclicals, the clear feature this week was demand for the more defensive parts of the market, namelyhealthcare and staples (thanks Erin Tolar for the data).13. did poor NDX breadth continue? no. as noted by Pete Callahan, coming into this week, 50 of 100 NDX names were down on the year, and NVDA alone had generated half of the index return. well, this week saw an improvement in breadth, particularly in the less-loved part of the stack, sufficient to drive a breakout from a 6-week consolidation.14. did the momentum factor finally spit the bit? no. despite a broadening of the rally, it just kept on flying. I have to admit, even for someone who stares at the basket quite a bit, this was a stunning data point: “since the dovish pivot at the end of last year, the US momentum factor has generated a 3-month Sharpe ratio of almost 8x” (link).15. finally, what’s a smart equity hedge right now? again, I prefer the strategy of retaining your length and looking for high quality hedges, rather than over-trading your core exposures. in that spirit, consider lookback puts on S&P. while more expensive than straight puts, the excess cost compared to the vanilla is low here, and in a clever manner, the strike resets higher should markets continue to rally over the observation cycle (i/m/h/o, this is the whole point here). it is well understood that vanilla puts are pricing low here as a function of volatility and forwards; this low level of vol, coupled with the upward sloping vol surface, make the lookback also price cheaply compared to history. structures and levels are easily available.Tony Pasquariello Goldman Sachs
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