Bob Janjuah: Euphoric In The Short-Term, Apocalyptic In The Longer

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Nomura's Bob Janjuah has released his latest Bob's World macro observations which won't come as a big surprise to most. As per the last time he forecast the future, Bob has a very bullish outlook on the short-term, where he sees the market potentially jumping into the 1400s, however turning very bearish into the longer-term: "In this risk-off phase I expect to see, as a proxy, the S&P down in the low 1000s by year-end/early 2012, and of course weaker credit spreads (Crossover over 500), weaker commodities, a stronger USD (DXY Index up at 77.5/80) and lower government bond yields/flatter curves (10 year USTs at 2.5%). In response to this risk-off move, as well as a move in the US unemployment rate to/above 10% by/around year-end, I expect to see policy responses  in the form of QE2 in the UK, QE3 in the US, and in the euro zone deep and meaningful (orderly) debt restructuring for Greece, Ireland and Portugal." As for the catalyst for the transition from the "short" to "long-term" Bob sees the following trigger: "Weak Trend Growth" - "Most policymakers and many in the market are still desperately hanging on to the view that trend growth rates in DM (and EM too) have not been impacted materially as a result of the financial crisis. To me the evidence is clearly ‘in’. The only way DM (and EM) policymakers have been able to deliver even barely acceptable trend growth has been through the use of unsustainable policies which put short-term gains first but which clearly create huge longer term risks to sovereign credit quality and which leave a deeply negative scar in the minds of the private sector, which is attempting to de-lever and which knows it is facing the mother of all tax liabilities going forward." Simply said: no more debt, no more growth: "The reality is that absent a private sector debt binge (the private sector is not that stupid) and assuming we are coming to or are at the end of the line with respect to policy, then DM trend growth over the next 3/5 years will be in the 1-1.5% range." Keep an eye out for ongoing debt trends at the private sector: according to Bob, this will be the key leading indicator for whether the trend at the DM, especially America, which has already been cut by the consensus from 4% to around 3%, is sustainable.

From Bob Janjuah:

Please refer to my last 2 Bob’s World notes (Reinitiating coverage & Vigilantes bite back) where I have outlined my market call for the next few weeks and months. As market developments and price action are very closely tracking the views I set out in my previous 2 notes, nothing has changed for me but I want to add some clarity. This really will be my last note before my summer break! In no particular order:

1 – Multi-day/Multi-week: To reiterate as clearly as possible, tactically I remain bullish the risk-on trade for now, and I expect to see, as a risk proxy, the S&P up at 1350/1370 over the next 4 weeks. Risk-on also means tighter credit spreads (Crossover at 370), higher government bond yields (10 year USTs at 3.4%),  steeper curves, strong commodity prices and a weaker USD (DXY Index at 73.5). The key drivers of this risk-on phase will be (compromised) deals relating to both the current US and euro zone debt issues. I do not see any solutions to the debt problems in any part of the DM economies anytime soon, but I do see fudged deals on the current live issues. I think Obama will ‘blink’ in the US and accept de facto a 1 year deal. And in Europe I expect another push by politicians to deliver us another round of ‘shock and awe’ headlines, mostly around the EFSF. In addition I think we will see ongoing ‘talk’ on the prospects of more QE3, a little more of the post-tragedy Japan bounce, and a settling down of the concerns around Italy, which to me, as long as the outcomes of last week (pro-Tremonti) can be executed, would take Italy firmly back into the core and away from the periphery.

To be clear, there are risks to this view, especially around the 2 big current debt issues in the US and the euro zone. As such, this week and next week can be volatile with markets responding to all/any headlines. But I think the big risks here are that we will get ‘agreements’ and, taken together with what is clearly very negative investor/market sentiment right now, and ‘gappy’ illiquid markets, I think risk markets may surprise to the upside over the fullness of August. And I would not rule out an overshoot, into September, where, as a proxy for this tactical risk-on phase, S&P gets into the 1400s (1440 tops I think). Which in turn will mean even tighter credit spreads, higher commodity prices, higher core government bond yields and a lower USD than the targets reiterated above.

After some further work I feel that over the course of the next 5/10 days, and again using the S&P as a proxy, my bear alert stop-loss to my tactically bullish call is at 1280. If we close below this level for more that 3 or 4 consecutive days then I will have to admit defeat and consider a much more immediate negative outcome for risk. The US debt ceiling issue will I think be key here.

2 – Multi-week/Multi-month: I remain very firmly bearish and risk-off, and based on what I can see now September/October is likely to be the pivot point from risk-on to risk-off. The key drivers will be the (latest!) inevitable breakdown of confidence in the sustainability of the euro zone absent restructuring (I see the outlook for fiscal union as extremely unlikely) , global growth concerns and heightened concerns around the fast diminishing policy options left open to DM policymakers, the ineffectiveness of policy to date and, linked to this, rapidly deteriorating policymaker credibility. In this risk-off phase I expect to see, as a proxy, the S&P down in the low 1000s by year-end/early 2012, and of course weaker credit spreads (Crossover over 500), weaker commodities, a stronger USD (DXY Index up at 77.5/80) and lower government bond yields/flatter curves (10 year USTs at 2.5%). In response to this risk-off move, as well as a move in the US unemployment rate to/above 10% by/around year-end, I expect to see policy responses in the form of QE2 in the UK, QE3 in the US, and in the euro zone deep and meaningful (orderly) debt restructuring for Greece, Ireland and Portugal.

Quite clearly I see the shorter-term tactical risk-on phase as also setting up a big and painful risk-off phase over the latter part of 2011 and 2012, as positioning and sentiment clearly need to get more bullish before we can get the kind of market weakness I am forecasting.

At this point it is worth repeating something to those looking for a ‘trigger’ to the risk-off phase. I think it’s as simple as 3 words: Weak Trend Growth. Most policymakers and many in the market are still desperately hanging on to the view that trend growth rates in DM (and EM too) have not been impacted materially as a result of the financial crisis. To me the evidence is clearly ‘in’. The only way DM (and EM) policymakers have been able to deliver even barely acceptable trend growth has been through the use of unsustainable policies which put short-term gains first but which clearly create huge longer term risks to sovereign credit quality and which leave a deeply negative scar in the minds of the private sector, which is attempting to de-lever and which knows it is facing the mother of all tax liabilities going forward. The reality is that absent a private sector debt binge (the private sector is not that stupid) and assuming we are coming to or are at the end of the line with respect to policy, then DM trend growth over the next 3/5 years will be in the 1-1.5% range. This I think is the key. Yes, there is too much debt in the balance sheets of the DM economies, particularly at the sovereign, bank and consumer levels. But if we all had confidence that DM trend growth rates could sustainably be 150/200bps higher than my expectation, then these debts would not be a major issue. However, at the kind of trend growth rates I expect to see, debt is a major problem, as are excessive risk asset values, as well as excessive ‘entitlement’ expectations. Once the market is able to see the limits of policy, and once the market is able to see through the excuses (of ‘soft patches’), then it is inevitable that we see a significant re-price lower of earnings expectations, of incomes, of asset values, and a genuine (rather than hypothetical) acceptance that living standards, especially in the DM economies, are going to be materially lower over the next 5/10 years than current consensus expectations/forecasts. EM economies will also see weaker trend growth, but they in general have strong balance sheets, huge flexibility in taxation and labour markets, and very low levels of entitlement expectations. Hence these (and similarly positioned DM economies) will ‘outperform’.

More on this later, once I am back from my break.