Edition #8 - 5.26.2021
CEO Confidence vs. Consumer Confidence, NAAIM Survey on U.S. Equities, Bitcoin's Anti-Fragility
Economy:
Last week, on May 20th, I saw a headline that read “CEO Confidence Hits All-Time High in Q2 [2021]”. The full report, provided by The Conference Board, is a survey & analysis of how CEO’s, across all industries & sectors, regard the economy & business conditions in order to understand the “major opportunities and challenges facing business, and to create consensus for solutions”. The article that I’ve linked above from The Conference Board highlights why CEO’s are feeling the most optimistic since the survey began in 1976. Here are some quick high-level points from that report:
94% of CEO’s surveyed said economic conditions are better compared to 6 months ago (up from 67% in Q1).
88% of CEO’s expect economic conditions to improve over the next 6 months (up from 82%, a previous record high, in Q1).
54% of CEO’s expect to grow their workforce over the next 12 months (up from 47%).
57% of CEO’S report trouble attracting qualified workers (up from 50% in Q1).
It’s great to see that the significant majority of respondents have strong outlooks, with beneficial implications, on economic conditions over the next 6-12 months. I did find it important to note that they are having an increasing difficulty attracting qualified workers, although that isn’t necessarily to say that they aren’t filling the roles that they’re hiring for. Depending on the industry, type of employment opportunity, and wages/benefits being offered, I still believe that this dynamic will be a mounting issue until the majority of unemployment benefits cease to pay out.
Yesterday, I saw a new chart that grabbed my attention because it seemed to run counter to the sentiment held by CEO’s. The headline was that “U.S. Consumer Confidence Fell in May for the First Time This Year”, with the following chart:
The headline is somewhat deceiving because the reading hardly slipped by -1% month-over-month, but it’s worth noting that a decline/stagnation occurred & that we’re still well-below the pre-COVID highs. Clearly, the Consumer Confidence Index shattered at the onset of the COVID pandemic & ensuing economic shutdowns (falling from roughly 133 to 85 between February 2020 and April 2020), and proceeded to spend the majority of the year under 100. It appears that consumers decisively reoriented towards a more optimistic view in November/December 2020, likely due to vaccination approvals by the FDA and the continued rollout/adoption of the vaccine treatments into 2021. This timing also correlates with more certainty regarding a transition of Presidential administrations, one in which many expected to see higher fiscal spending & stimulus under President Biden.
In any event, the Consumer Confidence Index has jumped nearly 35%, from 87 to 117, since December 2020’s result. With that said, it has yet to retake the levels from before the pandemic began. Meanwhile, CEO confidence regarding the conditions of the economy are at ATH’s. This led me to an interesting question which I don’t quite have an answer to: are CEO’s too optimistic or are consumers too conservative in their outlook on the economy? Perhaps neither are necessarily wrong, but are simply operating on different time scales. Either way, I expect the respective indexes to converge over time.
Stock Market:
In regards to the equity market, I saw the following chart:
At a high level, this shows the performance of the S&P 500 since 2017 with an underlying chart of the NAAIM Exposure Index. NAAIM stands for National Association of Active Investment Managers, which is a membership of investment managers who “provide active money management services to their clients, in order to produce favorable risk-adjusted returns as alternative to more passive, buy and hold strategies”. Essentially these are hedge funds or other registered investment advisory firms who attempt to provide uncorrelated alpha via active management.
The sub-chart of the NAAIM Exposure Index shows the average exposure to U.S. equity markets, given by the percent allocation to U.S. equities, for these active money managers. Per the NAAIM website, this weekly number “represents their overall equity exposure… and provides insight into the actual adjustments active risk managers have made to client accounts”. The most recent result for mid-May was a 44.2% allocation.
There are a few reasons why I’m interested in this chart. First of all, I modified the chart to add the red vertical lines, reflecting the level of the S&P 500 when the NAAIM allocation percentage dipped below 45%. Considering that this has only happened three previous times over the last four years, and is now occurring for the fourth time, it would be important to know how the S&P performed over the next 3, 6, and 12 months after the NAAIM Exposure Index dipped below 45%. These returns are taken from the $SPX, assuming that capital was allocated at the open of the week immediately following the signal:
11/12/2018:
3 months: +2.3%
6 months: +3.5%
12 months: +13.9%
12/10/2018:
3 months: +8.1%
6 months: +13.9%
12 months: +24.3%
3/2/2020:
3 months: +6.2%
6 months: +16.6%
12 months: +37.9%
Averages:
3 months: +5.5%
6 months: +11.3%
12 months: +25.4%
In each of the prior three scenarios, the S&P 500 was higher over the proceeding 3, 6, and 12 months. While the average return figures are very encouraging, that isn’t to say that stocks weren’t volatile during these periods. After the NAAIM Exposure Index fell below 45%, the S&P 500 suffered significant drawdowns of -7.6%, -23%, -10.5%, and -8.9% over the 12 months immediately following the signal. While we can look back on them with hindsight & know that things turned out fine, generating an average 12 month return of +25.4%, many investors panicked during these periods & let their emotions get the best of them. In order to generate an average return of +25.4%, investors had to be comfortable & willing to accept the pain of the drawdowns & volatility. Easier said than done.
The second reason why I like this chart is that it appears to act as somewhat of a contrarian signal. When active managers begin to reduce their exposure to the S&P 500 below 45%, the index has outperformed it’s historical 1-year average return! Alpha is most frequently generated when an investor avoids the crowd & takes the road less traveled. If an investor followed the actions of their colleagues, they wouldn’t generate any better (or worse) returns, therefore the variance an investor receives in the market is generated by acting different to the widely-accepted beliefs of the market. A famous quote from Baron Rothschild is that “the time to buy is when there is blood in the streets”. That isn’t to say that there is blood in the streets when the NAAIM’s S&P 500 allocation is beneath 45%, but I’m bringing it up simply to highlight the theme of contrarian investing.
I would not be surprised to see the S&P 500 move lower from these levels over the next 2-6 weeks, potentially by a margin of -5% to -8%. Similarly, I wouldn’t be surprised to see the S&P 500 gain +5% to +8% over the next 2-6 weeks. With that said, I personally don’t have much exposure to high beta names that would suffer more significant drawdowns & I don’t currently own any tech or growth-related companies, aside from a few Bitcoin mining firms. At the present moment, my trading portfolio is primarily concentrated in energy, materials, and consumer discretionary companies. I remain very optimistic & bullish on equity prices over the next 3, 6, and 12 months.
Cryptocurrency:
I’m not going to add much commentary, but here are two amazing quotes I read on Twitter today in regards to the crypto market:
“When Bitcoin crashes 50%, there are no bailouts and mainstream finance is quick to label it a Ponzi scheme. When traditional markets crash 50%, mainstream finance begs the Fed to print trillions of dollars & bail them out. One of these sounds more like a Ponzi than the other.” - @TexanHodl
While I don’t think either is a Ponzi scheme, I understand this person’s point. Raoul Pal, a macro hedge fund manager, added some color to this concept of an uninterrupted financial system:
A major asset class crashed 42% in 14 days, wiping out $1.02Tn in value… with very low regulation. Many tokens fell up to 70%, including unregulated lending and borrowing. No one was left holding the baby. No firm went under. The Fed didn’t need to step in. DeFi didn’t break & carried on near normal. No protocol failed. No firms needed rapid funding. The system didn’t break. It offered zero systematic risk to the broader financial world. Speculators lost money and that’s it” - @RaoulGMI
I absolutely love seeing this commentary, as it perfectly articulates the concept & importance of Bitcoin’s decentralized monetary network. I remain hyper-long Bitcoin & Ethereum, with an allocation split of roughly 80/20 for my crypto portfolio. I’ll continue to buy at these “distressed” levels & will continue to add even if/when it recovers. With that said, this is not financial advice.
Until tomorrow,
Caleb Franzen