A veritable smorgasbord of macro themes today starting with an old chestnut for this blog, cheap UK equities, then moving on to how European corporate earnings are rebounding nicely finishing with the $64 trillion question, why stockmarket volatility is still too high!

The UK is definitely cheap!

We start with the weekly note from the quant team at SocGen, repeating a message I’ve been droning on about for months (arguably years) now.

UK equities are cheap according to Andrew Lapthorne….

“Over the last three years, the total return in USD terms on MSCI World is around 29% meanwhile for the UK it is a shocking -15.5%, a relative underperformance that is as bad as when the UK was in recession and suffering rampant inflation back in 1972-74. Back then, UK equities fell 70% in just over two years despite profits almost doubling, resulting in a P/E of just 3.0x, i.e., performance was entirely driven by a de-rating in the wake of significant macro issues.

Which bring us to today. Over the last three years, of the 12 countries in the developed MSCI index that have seen market cap fall, the UK is responsible for 56% of that decline, i.e. more than the others countries put together, yet when you look at earnings performance the UK has actually beaten everyone else including, up until recently, the US. Of course, this is not the secular or defensive type of growth investors currently like to pay up for, but with the FTSE All Share in euro, USD and Yen terms at levels last seen in 1997, the UK may not be trading on a single-digit P/E but stands out as relatively more attractively valued than most alternatives in an otherwise expensive world.”

European earnings looking decent

Next up we have the excellent European equities team at Morgan Stanley reporting back on Q3 earnings across the continent. Some headlines are predictable – YoY EPS decline in the region of 30%; – but the range of outcomes (the breadth is interesting) with many beats and even some at the sales level. Overall the message is more upbeat than perhaps we all expected…

“1) A broad-based EPS beat versus consensus expectations…58% of companies have beaten EPS estimates by 5% or more, while 13% have missed, giving a strong ‘net beat’ of 45% of companies. If maintained, this would represent the broadest beat on data back to 2007, though we’d expect it to moderate slightly as earnings season progresses [ my emphasis added].  Where we have sufficient sector data, the breadth of beats has started strongly across Financials, Industrials and IT.

2)… Results have so far come in ahead of consensus, and weighted earnings are currently on track to contract by 30% YoY,a sharp improvement on the 61% contraction seen in 2Q20. ..

3)…The breadth of sales beats has so far been narrower than that of EPS with a net 24% of companies beating sales estimates. This suggests a beat on margins, consistent with the narrative we laid out in our 3Q earnings preview. …

4) …however, price reaction has been slightly negatively skewed. Price action has been modestly negatively skewed in 3Q and may suggest some degree of  good news around 3Q earnings is starting to become priced into markets. For example, sales beats have on average outperformed by 0.4% on the day of results, while sales misses have underperformed by 1.6%.

5) …. consensus expectations for 2020 EPS remain stable and currently point to a 33% year-on-year contraction for the year with a 40% rebound currently expected in 2021. Earnings revisions are broadly neutral at the market level with cyclicals seeing the best EPS revisions and defensives currently seeing the worst.”

Why equity volatility is still so high?

Last but no means least we finish with that $64 Trillion dollar question – why is equity market turbulence still so high even though some equity indices are currently hitting near term highs?  Case in point – the VIX is still 9 points outside its pre-Covid range (11-19) and in the 91st percentile. So, what’s sustaining high vol? Cue this weeks report on Investor Positioning from Deutsche Bank US analysts….

  • Realized vol is back within its pre-Covid range. Realized volatility fell steadily since March and by mid-July was back within its pre-Covid range. A selloff in mega-cap growth (MCG) and Tech, which then widened to other stocks, briefly saw realized vol spike up in September. As the market has rebounded since, realized vol has been falling again and is back within its pre-Covid range, as are the daily intra-day ranges in the S&P 500. Realized vol is closely tied to macro growth, and a continued steady recovery should put further downward pressure on it.
  • The elevated VIX since May has mostly reflected a higher vol risk premium. Until late April, elevated VIX was driven by higher realized vol, but since May it has reflected a sharp rise in the risk premium, even as realized has declined.
  • The vol risk premium has been closely correlated with bullish option buying by retail investors, particularly in MCG and Tech. Notably, the rising risk premium since May was accompanied by a very strong rally in equities. Indeed, the increase in the vol premium has been closely tied to very strong bullish option buying activity, a sharp break from the pattern earlier when increases in vol premiums mostly occurred around risk-off events and selloffs. As we have noted previously, the increase in option activity has been driven primarily by retail traders, particularly in MCG and Tech. After normalizing in September, bullish option buying has picked up again over the last three weeks, driving vol premiums higher (my emphasis added).
  • Election impacts evident in forward vol have collapsed. As the election poll gap widened over the last month, the S&P 500 rallied and forward vol curves collapsed, especially for post-election vol. This is evident in the S&P 500 option vol term structure as well as in the VIX futures curve.”

My message would be “Get ready to batten down the hatches! When it comes to resurface again be ready to buy UK and European equities….”