The Road Back to 3000

Michael Grant is preparing for rebound in equities and has positioned the long/short portfolio accordingly. To use a Wayne Gretzky analogy, he is skating to where the puck will be, not where it is.

Summary of Key Views

  • We believe there is a price at which you’re adequately compensated for the unknown. And when we look at the equity landscape, we believe we are there.
  • We see U.S. recession in 2020 as marking the end of the cyclical bear, not the beginning of one. In retrospect, we expect this market crisis to have lasted approximately three months. This interpretation argues for seeing further equity declines as opportunity. The initial wave of forced selling and price discovery will likely run its course by late March around 2400 on the S&P 500. Between April and early May, we think equities will have fully discounted the distress of transatlantic economies.
  • We believe equities are carving out an important bottom. This forecast includes some back and forth and testing of the lows over the next six weeks. Between April and mid-May, anxieties concerning the virus will dissipate. Investors will start to discount a recovery in the global economy from mid-year.
  • Under the surface of sectors and styles, equity markets have been anticipating this “late-cycle” setting since 2018. The transition to an investment regime driven by reflation and fiscal activism is underway. In turn, yield curves should begin to steepen and produce a rotational upheaval across equity styles. Equities are reaching valuation levels that are attractive for the long-term investor.
  • As the crisis has unfolded, the long/short portfolio has increased its net equity exposures to reflect the shifting risk/reward for equities. We have reduced shorts and added to long positions where the valuation reset appears extreme. We have focused upon quality balance sheets and robust free cash flow yields. One area of long focus has been defense companies. We also dipped our toe into a handful of energy opportunities (<8% of long exposure), albeit too early given the recent OPEC price war.
  • Commodities and oil have been at the front line of this crisis. The collapse of cyclically sensitive areas like energy has been so extreme that it should be complete by the end of March, coinciding with the low point of the Chinese economy. While oil may take a few months to adjust to the excess supply-demand situation, we expect stocks to bottom before.
  • We were ‘days’ too early in making some of these adjustments. The sell-off of early March was the most extreme since Black Monday in October 1987 (and we remember that day well). The last instance of three consecutive -9%+ days on the S&P 500 was in 1929. Our short put positions, whose pricing is negatively affected by heightened volatility, can affect the portfolio’s day-to-day performance relative to our net exposures.
  • The portfolio has shorted SPY puts at the 2300 level (June expiry), and these puts will effectively close out the bulk of our short S&P 500 position. In other words, we want to be buyers of equities at that level.