This page has been archived and commenting is disabled.

Why One Big Bank Is "Worried That The Market Is Stretched And Could Correct Rapidly"

Tyler Durden's picture




 

Aside from a relentless barrage of deteriorating geopolitical updates almost on a daily basis, which have led even the "very serious thinkers" to pull up comparisons to the days just before World War I, it has been smooth sailing for global capital "markets" which merely continue to follow the path of least central bank balance sheet resistance. It is this relentless melt up which has seen what was once a market and is has for the past 5 years become a policy vehicle to boost confidence (for whom, it is unclear: the vast majority of the population no longer cares what rigged stocks do, as for the trickle down wealth effect, 5 years of deteriorating real incomes for the middle class have promptly put an end to that fable) alongside a slow-motion LBO of the entire S&P 500, as companies repurchase trillions of their shares using ultra-cheap credit, bask in the glow of complacency so vast even the Fed is openly warning against it.

It is in this context that at least one bank, has voiced an alarm against pervasive, record complacency (that no matter how bad things get, the Fed will step in a bail everyone out, in fact the worse things get the better) after UBS' Stephane Deo released a paper titled "We are worried. We reduce risk - for now."

The key excerpts from the report:

Firstly we are concerned about valuations. We show that equity markets are stretched (e.g., more than 80% of the S&P rally since last year is due to re-rating), but we also find that the fixed income market has become quite rich (we have been overweight European peripherals for more than a year on valuation grounds, we show that this argument no longer holds), and the same is true of the credit market. Second because capital has been flowing rapidly into risky assets, we document that argument and here too find evidence that the market might be ahead of itself. We read the market reaction last week to the Portuguese news as a sign that the market is indeed too complacent and could correct rapidly.

Why we are worried

As we wrote in the previous section we remain constructive on risky assets over the medium term. However we think it is now time to scale down risk. The canary in the coalmine this time was Portuguese: The issue last week with Banco Espírito Santo (BES) had large impact on a variety of asset classes over the world. This includes other Portuguese banks, but also wider range of asset like the all SX7E index, the sovereign spreads in Europe and it even had an impact on the VIX. The various reactions from these asset classes seem large unless the BES event hides something much bigger and is the start of a new systemic crisis. This is not our central case scenario. In a recent note Bosco Ojeda explains that genuine improvements have been accomplished in peripheral Europe and the return of systemic risk is unlikely. Rather we think the event tells us a story about market positioning and market pricing: we think the market is stretched (more on that immediately below). If this is true, the market is already pricing most of the potential good news and is prone to react to bad news.

The pricing argument

Let's first look at pricing. We have argued that all the major stock markets are close to fair value. This is the case if we look for e.g. at our trend adjusted P/E, or if we look at our equity risk premium index. What is true though is that the recent momentum in markets is difficult to justify. The chart below shows that our economic surprise index has been very highly correlated with the S&P 500 until the beginning of last year. Since then the market has continued his rally with little fundamental improvement to support it. This divergence is becoming uncomfortably large.

And indeed, as we go to press, we get a helping hand from the Fed himself. The Fed said in a report that “valuation metrics in some sectors do appear substantially stretched, particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”

We also believe that the credit market is reaching tight levels. There are two additional characteristics of the credit market that worry us. First the quality of issuance has deteriorated as evidenced by a number of metrics: for instance the average rating of issuers has declined, the number of first-time issuers has increased, the number of payment in kind (PIK) clauses has surged, etc... Second the ratio between primary market issuance and secondary market daily turnover has greatly deteriorated, which is also a worrying sign. We have highlighted repeatedly in the past that the lack of liquidity in this market is a key issue for us and that it could prompt a sharp market over-adjustment.

* * *

Risk premium is the extra return investors demand to hold a risky asset above the return of a risk-free asset. Although excess return varies widely over time, particularly for equity, risk premium tends to be mean-reverting. This can either be estimated using expected cash flows as the rate that has to be added to the discount rate to back out current market prices. Or more simply we can look at historic excess returns.

In Figure 14 we can see the long-term excess returns of the assets in our portfolio against the excess return over the last year. The data have been sorted by return over the last year, and it is clear that the last year has been highly atypical. Equity, credit and listed real estate have had excess returns far above their long-term averages particularly in the UK and Europe. At the bottom of the bar graph volatility has been very low and the mid-term VIX futures index (SPVXMTR) has been losing value more quickly than usual.

It is interesting that some assets are broadly in line with their long-term average, such as US listed real estate, US high yield credit, and US Treasuries. The excess return of Asian listed real estate is actually below its long-term average. As a trading signal risk premium is very unreliable because it gives no sense of timing. But given the returns over the last year risk premia are certainly unfavourable.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Fri, 07/18/2014 - 14:05 | 4974480 hugovanderbubble
hugovanderbubble's picture

UBS first time doing the right thing

Fri, 07/18/2014 - 14:18 | 4974547 flacon
flacon's picture

What the fuck with these ads on ZH?! AdBlock doesn't even get rid of them! I'm sick of looking at that "BOIL" - it disgusts me. 

Anyway, S&P has been up SIX MONTHS in a row! That's very, very rare.  

Fri, 07/18/2014 - 16:05 | 4975123 Oracle 911
Oracle 911's picture

I'm using ghostery too. It blocks practically everything (even trackers and widgets).

Fri, 07/18/2014 - 16:11 | 4975148 bunzbunzbunz
bunzbunzbunz's picture

Google listed bitcoin as a currency...get some free now while the price is still in consolidation: http://freebitco.in/?r=25727

Fri, 07/18/2014 - 16:18 | 4975182 Joke Heros
Joke Heros's picture

My AdBlock has been working great for years, until about 2 weeks ago when the same block of ads appeared under each ZH article. Logged on yesterday and poof they were gone. Not sure what's going on here.

Strangely enough, the same spam ads were also appearing on my work computer when I was on m.sn websites. No Adblock there so I have to put up with them. Never click on any either.

Fri, 07/18/2014 - 14:24 | 4974587 AccreditedEYE
AccreditedEYE's picture

Ya, cause it is *always* smart to take these "Big Banks" at face value on everything they say. Yes lemmings, sell to UBS your longs... they have your best interest in mind. Only sale worth making is Volatility.

Fri, 07/18/2014 - 14:07 | 4974495 NoWayJose
NoWayJose's picture

But nothing has changed - values have been stretched for the past few years - but instead of saying it outright - the one reason the markets will correct is the end of QE.

Fri, 07/18/2014 - 15:26 | 4974917 Groundhog Day
Groundhog Day's picture

They will never ever ever correct.  New permanent highs, valuations dont matter, wars dont matter, economy doesnt matter, middle class doesn't matter

Fri, 07/18/2014 - 14:12 | 4974525 Thought Processor
Thought Processor's picture

 

 

The market is on autopilot.  Didn't this guy get the memo.....

 

 

Fri, 07/18/2014 - 14:14 | 4974533 NidStyles
NidStyles's picture

What market?

 

This is Skynet alpha 0.1.0 

Fri, 07/18/2014 - 14:15 | 4974537 Thought Processor
Thought Processor's picture

 

 

Exactly.

Fri, 07/18/2014 - 15:49 | 4975035 edotabin
edotabin's picture

Not to worry. We got a call in to John Connor.

Fri, 07/18/2014 - 14:57 | 4974750 fauxhammer
fauxhammer's picture

I believe the correct term is "Uninterruptible Autopilot".

 

And it is patented.

 

Question is, what are the destination coordinates?

Fri, 07/18/2014 - 15:39 | 4974985 Thought Processor
Thought Processor's picture

 

 

My guess is right into the ground at some pre-determined date.  Though only a select few will know that date- wink, wink.  Nod, nod.  You know what I'm sayin?  I think you do.

Fri, 07/18/2014 - 14:15 | 4974539 JRobby
JRobby's picture

Because it is, and they know it. Not to worry, the algos are switched on FULL BUY.

Fri, 07/18/2014 - 14:25 | 4974603 Four chan
Four chan's picture

since the crash the banks have hired employees who only know how to buy, not how to take profit. 

that leaves the rest of us experienced folk to pick off these noobs, i'm alright with that.

Fri, 07/18/2014 - 14:16 | 4974546 Dr. Richard Head
Dr. Richard Head's picture

We have highlighted repeatedly in the past that the lack of liquidity in this market is a key issue for us and that it could prompt a sharp market over-adjustment.

How many trillions of liquidity do these "market makers" fucking need?  I hope they drown.

Fri, 07/18/2014 - 14:17 | 4974560 TabakLover
TabakLover's picture

Oh they're drowning alright........ in top shelf booze.

Fri, 07/18/2014 - 14:16 | 4974550 TabakLover
TabakLover's picture

Just more "will", with no "when"

It's like a life expectancy analyst telling you - "you're gonna die some day". 

really!?!?!? 

wow, thanks.

 

Fri, 07/18/2014 - 14:52 | 4974730 Pheonyte
Pheonyte's picture

You can't predict dates and times in a complex dynamic system. But you can be sure that the system is fucked.

Fri, 07/18/2014 - 14:18 | 4974562 buzzsaw99
buzzsaw99's picture

the GPIF won't finish the latest rebalancing until October 2014. After that they will take the $5T in non-negotiable treasury bonds held in the social security trust fund and convert them into index funds. after that the fed will buy the entire stock and bond market. this bubble will never end because it isn't a bubble, it is just THE END.

Fri, 07/18/2014 - 14:29 | 4974619 khakuda
khakuda's picture

The Fed has allowed and encouraged the markets to go ballistic, up 50% over the past 2 years and, still, it's not enough as they keep pouring it on.  Did corporate America create one-third of its overall historic value in the past 2 years?

Yellen's idiotic talk about not raising rates to deal with looming financial bubbles was the mark of a fool.  They have ensured that from some, probably much higher level given current policy, a serious and economically debilitating decline is inevitable.

Given the ballistic nature of asset prices, the decline is likely on her watch.  She will be totally discredited and even the shoeshine boy will wonder how she could have been so foolish.

Fri, 07/18/2014 - 14:53 | 4974728 Jstanley011
Jstanley011's picture

Whenever it comes, an economic decline should be habilitating. Creative destruction, burn out the deadwood, let the grifters and brown nosers go broke, make things cheap for entrepreneurs and innovators -- not to mention show up the bullshitters like Yellen for what they are.

Either that, or given the low level of actual education and the destruction of common sense among the American electorate, a dictatorship might just be viable.

Whatever works, lol...

Fri, 07/18/2014 - 14:39 | 4974668 yogibear
yogibear's picture

The bots are programmed to dip, get the shorts excited and then ramp it up higher each time. Just incremental stealing by the bots from the shorts. 

Just buy the dips and it goes higher each time. same as it has been for 5 years.

Fri, 07/18/2014 - 14:56 | 4974745 Quinvarius
Quinvarius's picture

This market is going to get its nards crushed without more QE.

Fri, 07/18/2014 - 16:11 | 4975151 lasvegaspersona
lasvegaspersona's picture

QE?...nah..they'll call it something else and do it in a different way...

Fri, 07/18/2014 - 14:52 | 4974729 pakled
pakled's picture

"follow the path of least central bank balance sheet resistance. It is this relentless melt up which has seen what was once a market and is has for the past 5 years become a policy vehicle to boost confidence (for whom, it is unclear: the vast majority of the population no longer cares what rigged stocks do, as for the trickle down wealth effect, 5 years of deteriorating real incomes for the middle class have promptly put an end to that fable) alongside a slow-motion LBO of the entire S&P 500, as companies repurchase trillions of their shares using ultra-cheap credit, bask in the glow of complacency so vast even the Fed is openly warning against it."

 

Clever writing today. You guys are poets.

Fri, 07/18/2014 - 15:00 | 4974770 Fuku Ben
Fuku Ben's picture

Everything is priced into the market..

Except panicked sheep

Long sheep futures

Fri, 07/18/2014 - 15:28 | 4974938 Jim Shoesesta
Jim Shoesesta's picture

Anyone ever know the market to correct slowly?  zzzzzzzzzzzzz

Fri, 07/18/2014 - 16:03 | 4975115 khakuda
khakuda's picture

Ha.  Yes, years of gains wiped out in 3 weeks.  Never works the other way around.

Fri, 07/18/2014 - 16:09 | 4975138 lasvegaspersona
lasvegaspersona's picture

wait...markets 'correct?...

Fri, 07/18/2014 - 17:27 | 4975417 Haager
Haager's picture

Needs to happen before October, so that Yellen get's the opportunity to save the world by extending QE4Eva.

Do NOT follow this link or you will be banned from the site!