As noted earlier this week, the market hit a new high (or is that low) in complacency earlier this week when we reported that August has seen the least volatility since 1995. Goldman’s David Kostin picks up on this theme in his latest letter and writes that “the current streak of market stability represents the longest period without a 1%+/- daily move since the summer of 2014. Volatility has been similarly subdued with the VIX at 14.”
What is more interesting is that according to Kostin, the current environment makes “stock-picking” virtually impossible:
Stock picking has been challenging with three-month S&P 500 return dispersion ranking in the 4th percentile in 30 years indicating a tight distribution of company returns.
To be sure, he writes that some strategies have worked:” Cyclicals outperformed Defensives by 500 bp during the last month, Information Technology returned 4% while Telecom and Utilities both fell by 5%”, even as Goldman’s Hedge Fund VIP basket rallied by 3% (for reasons which as we explained last week, were mostly a short squeeze and a surge in leverage).
And yet, perhaps it is a function of the low dispersion that hedge funds, which at least on paper are supposed to generate the best risk-adjusted returns, are now dead last in the Sharpe ratio (risk adjusted return) league table.
So with volatility at near record low levels, stock-picking virtually impossible, and hedge funds underperforming every other asset class, what do they do?
Why go all in, of course: recall that year-end bonuses are due in just 4 months, and as of this moment they are not looking good.
The chart above shows the Goldman sentiment Indicator, which ranks net futures positioning versus the past 12 months. Readings below 10 or above 90 indicate extreme positions that are significant in predicting future returns. With the current 90 print, “predicted future returns” are sharply negative.