Fully three quarters of Japanese government bonds are trading at negative rates, and this has led investors to flock to foreign stocks, including those in the US, a JPMorgan Asset Allocation report noted. Does the US stock market have room to climb higher? Yes, the analysts said, citing additional capacity in managed futures CTA and Macro hedge fund portfolios.
JPMorgan: CTA and Macro strategies have room in their portfolios to accommodate more stock exposure
Leading into the Brexit from June 16 to 23, the algorithmic formulas driving CTA strategies were generally short equities, a JPMorgan report noted. After the Brexit sell-off, the analysis noted almost a halving of short positions from June 24 to 27 and then a positive positioning from there onward. Risk parity funds had generally consistent exposure while discretionary macro significantly tailed off exposure most recently.
To model hedge fund exposure to stock market “beta,” JPMorgan analysts Nikolaos Panigirtzoglou, Nandini Srivastava, Jigar Vakharia and Mika Inkinen in part use a relative value analysis formula. The consider the ratio of hedge fund returns relative to the S&P 500 index.
Based on this, they take three messages out of the current market environment:
First, despite CTAs raising their equity beta steadily since mid-June, their current equity beta is rather modest at 0.3x. Second, all types of investors have a positive equity beta but the beta of Discretionary Macro hedge fund managers appears to be very low, close to flat. Third, current equity betas stand below the high levels seen during the first half of June.
Considering this modeling, JPMorgan thinks CTAs and Discretionary Macro “could push equities up from here to even higher levels.”
Separate analysis indicates that determining a hedge fund’s exposure to stocks by examining performance relative to the S&P 500 might work well with funds that are primarily exposed to stocks. But CTA’s are, as a group, generally exposed to other commodity markets. In fact, looking at the outstanding Brexit performance, it could be argued that stock market exposure was not a significant point of causation of CTA outperformance, but rather the performance of trending markets where signals had been given before the Brexit vote.
Looking at separate proprietary CTA evaluation methods, the picture is mixed. Certain strategies had been short term positive but now some of the tighter momentum models could trigger short without a meaningful move down in stocks.
Japanese investors flocking to US as little room left to the upside is concern
One catalyst that might have been driving stocks higher recently could have been moves by Japanese investors to exit their local equity markets, a trend that hasn’t gone unnoticed. Raymond Nolte, chief investment officer of SkyBridge Capital, told Bloomberg Brief he has zero exposure to Japan-focused hedge funds because “unprecedented monetary stimulus has made the nation’s debt and equity markets too distorted to manage,” the report said.
This view squares with JPMorgan’s take on the investing world inside Japan.
“With Abenomics ‘fading away’ through the eyes of most investors, Japanese investors could be shifting into foreign equities as they see little potential in their domestic equities,” the JPMorgan report reasoned. The cause for concern? Investors might see little potential in their domestic equities. “After all, that was almost the default flow before Abenomics started at the end of 2012.”
But it’s not just Japanese investors who express concern. The JPMorgan report noted foreign investors have been moving away from Japanese issues. “Foreign investors got excited again about Japanese equities in April, ahead of the April BoJ meeting, but the BoJ disappointed them once again.” That said, on a very short term basis, equity purchases ahead of next week’s Bank of Japan meeting have increased to $4.2 billion, JPMorgan noted, making this the highest purchase level since the last BoJ meeting in April.