These are unusual times, to say the least. Few in the financial industry have seen a global pandemic and widespread economic shutdown, and we must approach our outlooks with a dose of humility.
Our Systematic Active Equity team is bringing together human insight and robust quantitative tools and techniques in seeking to illuminate some of the dark spots in the outlook.
Alternative data has been an area of intense focus for us over the past decade. And today, satellite images, foot traffic and transaction data are giving us a better read on the economy amid widespread global closures and re-openings. At the same time, the natural language processing of news flow, retail blogs and broker reports afford us a deeper understanding of investor sentiment and market reactions to policy responses. We combine these modern techniques with our investors’ deep understanding of the market from both a macroeconomic and finance perspective to better understand investment risk and opportunity.
To that end, we have identified three areas for investor consideration as the stock market has moved from the earlier phase of free-fall to the current phase of bottom-seeking and increased dispersion:
1. What can we learn from China?
Slowly but surely, China’s economy is on the path to recovery. The alternative data we track (satellite images, traffic congestion and transaction data) offers some hints as to how the recovery may play out in other parts of the world.
First, China’s recovery seems to be staggered and gradual. We see many differences across cities and provinces with a slower recovery in the more connected cosmopolitan areas and faster in the periphery. We think the recovery around the globe will also be uneven, with large country or geographic differences. This could imply country as a unit of analysis may be more important for investors going forward.
Second, we note China’s supply recovery has been faster (factories have re-opened) while the demand recovery (consumer activity) has been slow. It’s easier to ask people to go back to work but much harder for people to feel confident enough to book their next cruise vacation.
2. How long will current patterns persist?
While the overall market has been extremely volatile, we find the cross-sectional trends in the equity markets have not only been persistent, but even perpetuated: Momentum outperforming value, technology outperforming energy, the U.S. outperforming the rest of the world, and large cap outperforming small cap. These have been the prevailing trends over the past few years, and the current market volatility has not reversed but instead accelerated them. This is reminiscent of the late 1990s dot-com era when the winners in the market were concentrated and persistent ― until the pattern went to the extreme. We don’t seem to be there yet, but this is a significant source of risk going forward.
3. How much deleveraging ahead?
In the market free-fall phase that began in February, there was really no place for investors to hide. Risky assets of all sorts were punished, and the market drop was fast and furious. We then observed sharp hedge fund deleveraging in the middle of March similar in scale to that seen during the Global Financial Crisis and Lehman Brothers collapse. This “technical deleveraging” seemed to be partially over with some notes of market stability in late March and early April, and the popular hedge fund positions recovered a portion of their losses. This is an area we continue to monitor, as further hedge fund deleveraging and changing positions can feed back into broader risk-off sentiment.
What’s to come?
The only thing we can say with some certainty is change. The bursting of the dot-com bubble foretold a 10-year bear market for the technology sector. And 10 years after the global financial crisis, the banking sector hadn’t fully recovered.
We expect profound implications and changes to geopolitics, technology and capitalism after this crisis. The bottom-seeking phase will eventually transition into recovery mode, but the world is not likely to return to where it was in January of 2020. We remain students of the market as we put our human and quantitative capabilities to work thinking through the long-term implications.
Jeff Shen, PhD, is Co-CIO of Active Equities and Co-Head of Systematic Active Equity (SAE) at BlackRock. He is a regular contributor to The Blog.