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Bear Ahead? Goldman's Observations On The Schism Between Macro And Micro Investors; Weekly Charts

Submitted by Tyler Durden on 06/19/2010 10:29 -0500

David Kostin continues his attempt to reconcile the apparent incongruity between very bearish macro and just slighly bullish micro investors. In a recent trip to London, David Kostin conducts a detailed investigation on this divergence: "Through a combination of 1x1s and group breakfasts, lunches and dinners we exchanged views with a large cross section of macro equity, fixed income, and FX hedge funds, classic long/short equity hedge funds, and growth, value and global long-only mutual funds."

The take home is that really pretty much everyone (at least in Europe) has a bearish tilt. We wonder when Goldman will readjust its EPS expectations appropriately.

Here are his observations about how investors view the market:

1.Clients do not lack conviction. Our commentary last week discussed the tug-of-war between macro and micro data (Strong micro vs. weak macro: Understanding the Bull and Bear arguments for US Equities, June 11, 2010). This week we outline the dialogue with macro and micro investors. Clients currently have particularly strong views compared with the level of conviction expressed during previous visits. Sometimes investors have a relatively neutral view of opportunities and risks and position themselves for a variety of market outcomes. We did not find that to be the case this time.

2.Macro-driven investors have a bearish view of US equities and are positioned accordingly. By macro-driven investors we do not mean exclusively macro hedge funds but rather any investor who views the investment decision process from a top-down perspective. Many long-only investors as well as FX and equity hedge funds fall into this category.

3.Macro-driven investors view price action as the starting point for their investment discussion. Specifically, this group of clients interpreted the recent 14% drop in the S&P 500 through an economic lens. The term most commonly used to describe the correction was fallout from the economic “shock” of heightened sovereign credit risk in Europe. These investors argued that the US stock market decline appropriately reflected the downshift in fundamentals and greater likelihood of contagion to the US.

4.The macro-oriented community expressed a fairly consistent set of bearish beliefs: (a) European sovereign debt problems would persist for an extended period; (b) Euro would continue to weaken and could fall towards parity vs. US Dollar from current 1.23; (c) Sovereign debt crisis eventually would spread to the US and would probably come sooner than many currently expect; and (d) Both US and European equity indices do not reflect reduced economic growth prospects for developed markets from tighter fiscal policy necessary to address sovereign credit concerns.

5.Micro-driven investors were more balanced in their views than their macro counterparts, although only a few could be described as bullish.

6.Micro-driven investors expect and are positioned for US stocks to outperform European stocks in both local currency and US Dollar terms. Several investors noted they were currently more overweight US stocks in their portfolio compared with their historical allocations. Faster relative EPS growth of US firms was cited by several fund managers as one argument for the overweight positioning. The lack of a continent-wide bank stress-test analogous to the Fed’s 2009 report on the health of systemically-important US financials firms was identified as a headwind for European share prices. If such a test is conducted, and the exam is perceived to be rigorous, necessary dilution would be known, capital could be raised, and broad indexes could rally. Such a test is being discussed but there are no details.

7.A key difference between the micro and macro schools of investing is how precedent and incremental data points are processed. Macro investors focus on price action because they believe it incorporates shifts in macroeconomic trends and associated risk premiums. However, when shown empirical data from the initial recovery phase after previous bear markets in 1974, 1982, 1987, 1990, and 2002 that the magnitude of the rebound, the frequency of pull-backs, and the size of the corrections since March 2009 are entirely consistent with prior experience, the observation is dismissed with the claim that the current sovereign debt crisis is unique (see Exhibit 2).

Similar arguments were undoubtedly made before. In 1975, after the S&P 500 had rallied 53% from its 1974 bear market low, the index dropped by 14% as bankruptcy loomed for New York City. The fate was only narrowly avoided through the creation of an off-balance sheet SPV after the Federal government rejected a plea for funds. Familiar-sounding parallels?

8.Macro clients also dismissed every incrementally positive company data point with the statement, “Yes, but the next data point will be negative and reflect the second-half slowdown. Don’t you recall how fast business activity collapsed in 2008; why won’t we repeat that experience in 2010?” The profit cycle is expanding now in contrast with two years ago when it was contracting. Firms are vigilant on their cost structure and margins are close to all-time highs. Although order books could collapse, data points indicate we are in a sharp “V”-shaped profit recovery, even if economic growth remains weak.

http://www.zerohedge.com/article/goldmans-observations-schism-between-macro-and-micro-investors-weekly-charts