Risk Premium

About That 2100 S&P Target For 2015, Goldman Was Only Kidding, Now Sees Even More Ridiculous Multiple Expansion

It was just one short month ago when, on the back of the soaring dollar (which has since soared even more), as well as "diminished global GDP growth and lower crude prices", Goldman's David Kostin cut his EPS for 2015 and 2016 from $125 and $132 to $122 and $131. Then, it was just two short weeks ago, the same David Kostin said "we expect the P/E will contract and the index will slip during the second-half of 2015 as the Fed takes its first step in the long-awaited tightening cycle. Our S&P 500 year-end 2015 target of 2100 implies a modest 5-10% P/E multiple compression to 16.0x our top-down 2016 EPS estimate or 14.6x bottom-up consensus earnings estimates." And then, with the S&P now about 20 points away from Goldman's 2015 year end target (and just 120 points from the government-backed hedge fund's 2016 year end target!), the very same David Kostin admits that he was only kidding and that the S&P may in fact rise to a whopping 2300 in the coming year...

'We Are Entering A New Oil Normal"

The precipitous decline in the price of oil is perhaps one of the most bearish macro developments this year. We believe we are entering a “new oil normal,” where oil prices stay lower for longer. While we highlighted the risk of a near-term decline in the oil price in our July newsletter, we failed to adjust our portfolio sufficiently to reflect such a scenario. This month we identify the major implications of our revised energy thesis.  The reason oil prices started sliding in June can be explained by record growth in US production, sputtering demand from Europe and China, and an unwind of the Middle East geopolitical risk premium. The world oil market, which consumes 92 million barrels a day, currently has one million barrels more than it needs.... Large energy companies are sitting on a great deal of cash which cushions the blow from a weak pricing environment in the short-term. It is still important to keep in mind, however, that most big oil projects have been planned around the notion that oil would stay above $100, which no longer seems likely.

Goldman Sachs Is Buying Carl Icahn's "High Yield Bond Bubble"

High-yield bond issuance has surged in recent days as 'wide' spreads have encouraged investors to take the dip once again (despite firms' record leverage and increasing desperation to roll the wall of maturing debt). However, it's not all guns blazing, as one manager noted, "while the market reopens, it reopens with issuers having to be a little more investor friendly." Despite Carl Icahn's warning that "the high-yield bond market is in a major bubble that's gonna burst," Bullard's "QE4" comments sparked Goldman to add US junk bonds and Aberdeen says selling EU and buying US corporate debt "is the trade that kind of screams at you right now." The dash-for-trash down-in-quality is back as CCC-demand surges and, as one trader notes the market's schizophrenia: "one day the market feels like it is shut down and you can’t sell anything and you wake up this morning and you can price any part of the curve."

The Unwind Process Has Far To Go (And Don't Hold Your Breath For QE4)

The Fed’s policy of financial repression sends the wrong signal.  It punishes savers, such as pensions and retirees, while rewarding speculators and debtors.  It is like giving my son ice cream after he yells at his mother and punches his brother. Many Fed policies have been, or have become, counter-productive.  Events may certainly force the Fed to be ‘lower for longer’, but expecting some type of new stimulus measure is an exceptionally long way off. The explosion of market volatility has shaken the foundation of investor psyche. The unwind process has far to go.

Hussman Warns Beware ZIRP "Hot Potatoes": Examine All Risk Exposures

"Present conditions create an urgency to examine all risk exposures. Once overvalued, overbought, overbullish extremes are joined by deterioration in market internals and trend-uniformity, one finds a narrow set comprising less than 5% of history that contains little but abrupt air-pockets, free-falls, and crashes."

Investors Are Too Comfortable In The Fed's Win-Win Conditions For Taking Risk

For a long time, Fed printing via balance sheet expansion has been the key to understanding markets and the predominant driver that has trumped all other matters.  Investors have been able to ignore significant global events, tensions, and economic conditions in faraway places, because a lower real and perceived risk premium from implicit Fed promises was the single most important aspect driving asset prices higher.  This game is quickly coming to an end. As the Fed’s asset purchase program ends next month, global events and global economic fundamentals will have to be taken into account and priced accordingly.

5 Things To Ponder: "Bear-ly" Extant

"It is a bad sign for the market when all the bears give up. If no-one is left to be converted, it usually means no-one is left to buy.” The extraordinarily low level of "bearish" outlooks combined with extreme levels of complacency within the financial markets has historically been a "poor cocktail" for future investment success.

Spain Bond Yields Spike Most In Over A Decade As "Referendum Risk" Spreads

As we warned earlier, there is the potential for broad risk premium re-pricing across European nations on the back of Scotland's independence referendum decision; and nowhere is that more evident in the last 2 days than in Spanish bonds. So-called "referendum risk" - in this case related to Catalan independence - has sent Spanish bond yields up over 17bps (over 8.1% - the biggest single day jump since before the EU was formed) and risk spreads are 12-15bps wider as the UK experience (with growing support for UKIP alongside faster economic growth) raises the issue that economic recovery alone may not be enough to reverse the rise in anti-elite, anti-establishment sentiment across Europe.

Sterling Volatility Spikes To 3-Year High As Scottish Independence Nears

The dramatic rise in support for Scottish independence is nowhere more evident than in GBPUSD implied volatility, which has soared to 3-year highs as The Guardian reports a further poll showing next week's referendum is on a knife-edge with a gap of just 1 percentage point between yes and no. As one 'Yes Scotland' representative noted, "This new Scotland could be less than a fortnight away. But we must not be complacent. The scaremongering, dissembling and misrepresentation of the no campaign will be ramped up as we approach polling day." Of course, Scotland is not the only EU nation seeking separation, as we illustrate below, and as Goldman Sachs notes, there could be a broader impact on the risk premium across Europe as Scottish independence leads to other calls for more regional autonomy.

John Hussman's "Exit Rule For Bubbles"

History teaches clear lessons about how this episode will end – namely with a decline that wipes out years and years of prior market returns. The fact that few investors – in aggregate – will get out is simply a matter of arithmetic and equilibrium. The best that investors can hope for is that someone else will be found to hold the bag, but that requires success at what I’ll call the Exit Rule for Bubbles: you only get out if you panic before everyone else does. Look at it as a game of musical chairs with a progressively contracting number of greater fools.