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The Big Conversation

Episode 91: Is the bearish stock market consensus wrong?

This week Real Vision’s Roger Hirst uses Refinitiv’s best-in-class data to look at the consensus amongst equity strategists for a 10% to 20% correction in the US stock market. Most market professionals expect a 5% to 10% correction. But is this now too much of a consensus to actually come true? In the Chatter, consumer trends are changing, and Generation Z is at the forefront of this change. China has a huge Generation Z cohort. Keith Wu, CEO of WeTrust Asset Management, talks to Real Vision’s Roger Hirst about the trends within this age group that could drive consumption patterns throughout the next decade.

  • Roger [00:00:00] Over the last few months, the S&P500 has been grinding out new highs with regular monthly pullbacks, testing the 50-day moving average. Now many see this coiling effect as a prelude to a more significant correction, but that view is now a massive consensus. In this week's Big Conversation we look at some of the pros and cons of this outlook and the influence of the options market and what that's doing to price action. The expectation of a pullback in the U.S. stock market is rife amongst institutional investors and major investment banks. At six of the biggest banks, strategists are looking for 10 to 20 percent decline as we pass through that traditionally difficult period from September through to December. Though past statistics are heavily skewed by the 1987 crash, which wiped out 20 percent in a single day, and the 40 percent decline at the end of 2008. In a recent Deutsche Bank survey of 550 market professionals, nearly 70 percent expects a correction of up to 10 percent or more before the year-end. With the second-lowest reading in a year only 14 percent expecting the market to be higher in three months time. There are some very decent arguments for that bearish outlook. The trend channel for the S&P has been getting narrower and narrower. The actual volatility of many global indices has been falling, but low levels of volatility are often a precursor to much higher levels of volatility because investors often use increased leverage when these conditions prevail. Household margin debt is suddenly rocketed in the last 18 months, having gone nowhere for the previous five years. The inflows into equities over this period is greater than net inflows of the previous 20 years, according to Goldman Sachs. Bollinger bands reflect levels of realised volatility. On the German DAX, they are the tightest level since 1996, according to Julian Brigden of MI2 Partners. In recent weeks, he notes that the last time the Bolly bands were this tight in 1996, the DAX rallied 82 percent. Prior to that in 1992, when they were tight it fell 20 percent. Stock correlations also provide insights to fear and complacency. During panics, they trend towards 1, in times of complacency they trend towards zero. Independent research has Sentiment Trader notes that the correlation amongst US technology stocks is currently at a three-year low. Furthermore, valuations are at nosebleed levels. But then again, they've been that way for many years. The performance of the S&P long ago left behind the profitability of its constituents. The S&P is again testing its multi-month uptrend. The pullbacks over the summer have been around the monthly options expiry, which takes place on the third Friday of each month, and this month is no exception. The September expiries on Friday the 17th, there could be in excess of three trillion dollars of index, ETF and stock options expiring on Friday, and this should see significant vega and gamma drop out of the market once more. Expiery is probably the culprit for these monthly dips. So far, none of them have persisted beyond this event. Options are dominating underlying volumes. Goldman Sachs has calculated that the traded notional volume of S&P options is 200 percent of the underlying futures market. It was around 100 percent in 2016 and under half of that before the financial crisis of 2008. Now, last Friday, the notional volume of options was around two trillion dollars. Apparently, that's a record. Now, the prospects for investors wanting index hedges is not great at the moment. Skew in the S&P 500 is historically high, though it's dropped a little, these are still near record levels. Now, skew is the difference between the volatility in the lower strike, such as the 90 percent vs. upside strikes, such as the 110 percent. For an equity index volatility is usually higher in the lower strikes. Today the volatility of the 90 percent strike is far higher than the actual volatility of the index. These are not cheap options to buy. So does that mean that the market is already hedged and the downside risk is reduced, or does it mean that the cost of buying protection is too expensive and none has been put in place? Well the answer is a bit of both. The high skew is due to a proliferation of buying deep out of the money puts, such as the 85 percent strike or lower to hedge for an extreme event. Whilst a tail event may well be hedged, it probably means there are very few basic market hedges in place for a 5 to 10 percent correction. The put/call ratio is currently quite low. Now, this could be higher call volumes, but it may also be fewer puts being bought because of those high costs. And this is the conundrum. The market looks extremely stretched and vulnerable, but that has become a massive consensus. And can the consensus work? Well investors are undecided, but they have been using skew to their advantage. Those calls, the upside calls, they look cheap compared to the puts. So rather than buying protection, some have been rolling out of stock portfolios and replacing them with calls, and that risk profile looks more attractive. Some institutions have lagged the rally so far and would welcome a pullback. Selling an S&P 500 three-month 90 percent put indicatively receives about 1.3 percent. Now the 25 vol of this strike compares very favourably with a three-month realised volatility on the S&P of 10. If the market sells off 10 percent by expiry, they will get long their strike. Aggressive institutions are even looking at selling puts to buy multiple calls for zero cost. And that's a leveraged bet that a pullback would be a short-lived affair and that the bigger risk is still a retail rally into year-end. Now, obviously, anyone selling an option does need to understand the risks. So today the US market is delicately poised, with the options market a pivotal factor. And even if we do get a pullback, well, that's now a massive consensus. The last few years have suggested that these short, sharp affairs are extremely difficult to time. But distortions in the options market are providing some excellent opportunities to offset some of those risks. Millennials and Generation Z have been shaking up the trading mindset. They will also define future consumption trends. In the next section, we look at how one country's generation Z is shaping its demand outlook.

    Roger [00:06:08] For much of the last few decades, consumption trends have generally been dominated by the boomer generation. But as they age, the drivers of consumption are already shifting towards millennials and increasingly now the generation Z cohort, although globally a smaller group than the boomer generation, the consumer trends of Generation Z born into the digital age will be significant. Now, the size of China's generation Z is huge in absolute terms. The consumption trends of this group are being shaped by technological developments and more recently, the lingering effects of the pandemic. Keith Wu. CEO of WeTrust Asset Management outlines the impact this generation is having on current and future consumption trends.

    Keith [00:06:44] My name is Keith Wu. I'm the founder and Chief Executive Officer of WeTrust Asset Management. Based out of Singapore WeTrust runs a China focussed long-short equity strategy specialising in the consumer and technology sectors in China.

    Roger [00:06:58] Generation Z is a key consumer group within China. They are a tech-savvy mobile generation whose consumption patterns are anchored within the online world.

    Keith [00:07:06] We define Generation Z as individuals born in the late 1990s to 2010. Today they are at their late teens to mid-20s. To size up, Generation Z makes up approximately 20 percent of China's total population, or two hundred and seventy-five million Chinese buyers and consumers, about the same population of Germany, UK, France and Italy combined. So what makes Generation Z a key consumer group in China is really their maturity and self-awareness as consumers. Generation Z is a 'mobile phone generation'. The typical Chinese Gen Zers spend lengthy amounts of time on their phones. They overwhelmingly rely on their phones for information and for socialising. We see a few large and powerful social media apps in China, such as WeChat, DouYin and KuaiShou, monopolising their time, leveraging on their behaviour data and influencing their consumption choices. But compared with the older generations in China, Generation Zers know what they like when it comes to brand names and they are able to articulate who they are and what they value. They are confident and savvy consumers in our eyes, and that is why they've become increasingly important in China's consumer markets.

    Roger [00:08:31] This is a generation that's embraced the virtual world of connectivity and evolved with opportunities that technology can provide, shifting towards a home based lifestyle that other generations have also actually started to embrace.

    Keith [00:08:42] You know, in Mandarin Zhai actually means 'staying at home' and to some extent it implies an unwillingness to go out. For a generation born with a smart pad or a phone in hand, the Zhai lifestyle makes sense. In fact, it is already the metaverse for that. We are seeing in this generation, instantaneous satisfaction of Internet stores replacing the social department store experience of the old. So why shop at one physical address when the Internet virtually opens thousands of shopping addresses with greater convenience and cheaper prices? Also hurting the physical shopping experience is the food industries that support it. Less shopping at a department store means less dining time and fewer lunch breaks in the mall. For Generations Zers, the convenience of food delivery is valued more than the restaurant experience, and moreover Covid-19 since last year, has been highlighting to us and to the other generations the benefit of the Zhai lifestyle. Parents willingly or not, are embracing the benefit of online tutoring versus the in-person classroom. Business professionals are also embracing the virtual face-to- face meeting. Adults are learning to cook at home with the help of the geeky, smart home appliances. Everyone is embracing the online media and entertainment experience over the cinema megaplex. This trend goes beyond the obvious winners like Tencent, Zoom and Douyin and Kuaishou. The trend actually digs deeper into big and small companies very willing to make your life, stay at home life experience a permanent choice. And finally, Generation Z also embraces the phone as their main source of payments and even storage of wealth. For them, this is how they engage money. This is why you see the Generation Zers behind the success of WeChat Pay, Alipay, pay now, buy-now and pay-later phenomena. And some very brave and bold young Generation Zers are actually driving the blockchain economies from Bitcoin to ETH from De-Fi to you know NFTs.

    Roger [00:11:15] Understandably, Chinese brands have dominated the consumption patterns of Generation Z. The popularity of these brands can go viral, making this an ever-changing landscape.

    Keith [00:11:24] As I said earlier, Generation Zers are confident and savvy as consumers. They don't blindly embrace the overseas brands as the winner of their RMB. They have lived during a time when Chinese consumer brands have gradually won the heart and soul of the young. Many domestic new fashion brands being able to leverage on the power of social media marketing and the value of word of mouth through the viral WeChat, Douyin, Kuaishou and Xiaohongshu, are able to quickly build up their fans and follower's circles that result in various billion-dollar business across the food and beverage, cosmetics, sportswear and consumer electronics industries. Energetic Forest, for example, is a very popular Chinese beverage brand amongst Generation Zers for its zero sugar soda drinks. Perfect Diary is another good example. It is a young cosmetic brand getting viral amongst Generation Z, young women in China today. Still, I need to point out that the fierce competition and dependency on potentially short-life social media popularity make it quite difficult to identify who are the long-term winners amongst many young Chinese brands.

    Roger [00:12:44] Although the popularity of domestic brands dominates demand, there is still a place for many of the best-known international brands that have already got a foothold.

    Keith [00:12:52] Generation Z consumers are more and more confident in Chinese domestic brands. Having said that, the international luxury brands and super products I think will continue to enjoy success in China. The reason is China is still the largest growing affluent and upper-middle-class consumer market in the world. And more importantly, international brands are learning to leverage China's powerful online platforms to reach 3rd tier, 4th tier and 5th tier cities that they never entered into in the past via a physical presence. Like Chinese domestic brands, they are doing this without the cost and trouble of building complex distribution channels to sell to these new consumers in lower-tier cities. So that is why I'm seeing the continued success of brands like Apple, Chanel and Tesla as great examples of international brands' ongoing success with Generation Zers in China.

    Roger [00:13:52] Recent policy developments are aiming to reduce the dominance of some of the mega brands, but this should help to increase the variety of choice for consumers.

    Keith [00:14:00] I believe what the latest measure of Chinese government have implemented, or are going to implement soon with regards to the internet economy, are for the industry's healthy and orderly growth over the long run. For example, lowering the revenue split, revenue sharing of the and the advertisement costs of the restaurants on the, on the food delivery platform will help the survival of many boutique restaurants, and therefore giving the 'stay at home' Generation Z consumers more variety of food choices. Similarly, the young domestic Chinese brands will also enjoy better exposure online at lower costs, with the government taking preventive measures against information monopoly amongst a few mobile Internet super apps.

    Roger [00:14:49] Keith has watched the development of consumer trends in China over many years, and is firmly of the belief that Generation Z will be the wavefront of some of the biggest future opportunities.

    Keith [00:14:59] So in summary, we think that Z Generation, in China, it has now actually been referenced in China as the 'Late Wave'. The 'Late Wave' terminology, the 'Late Wave' term originates appropriately enough from China's online video sharing platform. Bilibili, most popular amongst the Generation Zers. 'Late Wave' or 'Hou Lang' in Mandarin, implies a more superior and more potentially impactful group than the prior wave of the older generations. So no doubt the battle to win the hearts and minds of the 'Late Wave' is fierce and ongoing. We think that whoever wins the battle, will win the share of pockets of Generation Z consumers in China, and that is why at WeTrust we are squarely focussed on these trends to guide our consumer sector investments. And we believe our continued learning and understanding of Generation Z consumers will guide our investment success in the future.

    Roger [00:16:06] Whilst many of the consumption patterns of China's Generation Z are specific to that country, there are also many trends that will be recognisable to this generation the world over. The shift to online consumption has been adopted across the world. Many people outside this age group have also embraced some of these consumption characteristics due to the impact of the pandemic. Now whilst each region will have its own specific trends and styles, it's probably fair to say that the consumption patterns of Generation Z, along within many areas The Millennials, are likely to define the most successful brands over the next couple of decades. If you've got any questions about this episode or anything else to do with financial markets, please do put those questions in the comments section or send them to TBC@Refinitiv.com