This is a really trashy rally

Markets have started the year where they ended 2021, rallying on hopes that inflation has peaked, central banks are about to pivot and the global economy is doing a lot better than feared.

This has lifted most boats, both in equities and fixed income. The MSCI All-Country World Index climbed 7 per cent in January, while the Bloomberg Global Aggregate bond index is up 3.3 per cent. In terms of breadth, this is the best start to a year since 2019, according to Deutsche Bank.

And this is a proper risk-on rally. Consumer discretionary is the best performing sector, which is . . . counter-intuitive in a cost of living crisis that many people think will morph into a recession. Meanwhile, utilities, staples and healthcare are all down.

In fact, on closer inspection it’s pretty remarkable/hilarious/unnerving (delete according to personal bias) how much the January rally has been powered by, well, absolute trash. Here are some of FT Alphaville’s favourite speculative dumpster fires and how they’ve done so far this year:

Crypto:

Meme stonks:

Spec tech:

Private markets

• VanEck’s BDC ETF: +8.3 per cent

• Invesco’s private equity ETF: +13.3 per cent

• Blackrock’s REIT ETF: +10.7 per cent.

Misc trash

• Carvana: +114.6 per cent

• SPAC index: +20.1 per cent

• Stockholm’s OMX: +7.8 per cent (ed note; the author is Norwegian)

• Deutsche Bank: +15.5 per cent (ed note: ok fair enough)

Here, in chart form from Credit Suisse, is what that looks like in terms of factors. Anything volatile, and/or that was beaten up hard in 2022, and/or is crypto-adjacent, and/or is unusually linked to economic growth, has had a fab start to 2023.

The question is whether this is a post-growth scare rally — a milder echo of we usually see after bad recessions end and markets begin bouncing again — or the return of BTFD that will end badly.

As Credit Suisse’s Patrick Palfrey pointed out earlier this week, trash high-beta rallies like this are common after recessions or crises trigger big market setbacks:

While bearish investors opine on the likelihood of recession, the market has advanced 12.8% since early October, 5.1% over the past month. However, it’s the market’s YTD leadership that’s most notable, with the most beaten up, economically-sensitive, speculative and volatile stocks leading. Many are calling this a “junk” rally; however, quality measures — such as ROE and financial leverage — are having little impact on returns. Interestingly, both price and fundamental momentum factors have rotated out of favor. This pattern of performance is typical in the aftermath of a crisis (post-dotcom period, 9/11, or GFC) or following a severe recession.

Here’s a CS chart showing how the recovery of 2022’s burn victims stacks up compared to similar periods.

Can it last though? Palfrey doubts it. He reckons that slower inflation, a central bank pivot and the fading danger of a recession is now in the price. Even if all these hopes are realised, it means the January trash rally might struggle to sustain itself.

In October, following a period of multiple contraction and rising volatility, we wrote “we expect a reversal of spreads and volatility, leading to 1-2x multiple points of rerating through year-end.” Since that time, inflation has fallen precipitously, recession risks have declined, and expectations of a Fed pivot in 2Q have increased. As a result, the VIX and spreads have corrected, and multiples have re-rated higher. Unfortunately, we believe the impact from these positive catalysts have largely played out, limiting both the market’s upside and the continuation of January’s leadership.