JPM's "Gandalf" Quant Is Back With A Startling Warning

Tyler Durden's picture

Two days ago we reported that one half of JPM's Croatian "Duo of Doom", namely equity strategist Mislav Matejka, became every BTFDer's worst enemy when he said that the time of BTFDing is over, and a regime change has arrived one in which rallies are to be sold. To wit:

Our view is that the risk-reward for equities has worsened materially. In contrast to the past 7 years, when we advocated using the dips as buying opportunities, we believe the regime has transitioned to one of selling any rally. Yes, stocks had a rough time most recently, and some of the tactical indicators, such as Bull-Bear at -16 which is at the bottom of its trading range, argue for a short-term respite. Clearly, equities are unlikely to keep falling in a straight line, with periodic rebounds likely. However, we believe that one should be using any bounces as selling opportunities.


We fear that the incoming Q4 reporting season won’t be able to provide much reassurance for stocks. As was the case for a while now, consensus expectations have been managed aggressively into the results. The hurdle rate for Q4 S&P500 EPS has fallen from +5%yoy a few months back to -4%yoy currently. If this were to materialise, it would be the weakest quarter for EPS delivery so far in  the upcycle.

Today, the other half of the infamous Croatian duo...


... the legendary "Gandalf" (as dubbed first by Bloomberg) quant Marko Kolanovic, who needs no introduction on this website, and whose every prediction starting in late August turned out just as predicted...

... is out with a new note which will hardly make him any more popular with the permabullish crowd, asks whether "negative  performance in 2015 and January, turmoil in China, and continuing decline in Oil prices make investors wonder if this could be the end of the nearly 7-year bull market."

His short answer:

"The fact that market volatility is on the rise and the Fed is raising interest rates further increases the probability of a Bear Market. The current option-implied probability of a bear market (i.e. ~20% decline this year) is about 25%. While there is no way to predict a bear market, below we look at various scenarios, and estimate that the probability of a bear market may be nearly twice as large."

So according to the man whose every market forecast has been so far impeccable, the probability of a bear market: or a 20% or more drop in the S&P500 - is roughly 50%.

Not good.

And what will make the permabulls even angrier is his proposed allocation to avoid the bear market:

In case an equity bear market materializes this year, investors should benefit from increasing allocation to cash or gold. Cash has zero correlation to all risky assets, while Gold has recently exhibited strong negative correlation to risky assets (e.g. -40% to equities).

* * *

This is what else he says:

from Systematic Strategy Flows, Oil Prices and the Risk of an Equity Bear Market

First, let’s look at relationship between Oil prices and S&P 500. Oil prices recently posted some of the fastest declines on record. Over extended periods of time, Oil and S&P 500 were positively correlated. Figure 4 shows the out/underperformance of Oil relative to the S&P 500 over the past 30 years (trailing 12M relative performance). One can see that that in each of the 10 episodes of large Oil-S&P 500 price divergences, the gap was always closed in a relatively short time period. Significant underperformance of Oil (e.g. >30%) in 8 out of 10 instances resulted in either a decline in the S&P 500 or large Oil rally. In 2 instances, namely shortly after the start of the Gulf Wars in 1991 and 2003, the decline in Oil was a result of overbought conditions immediately prior to these events. One of the largest swings in Oil-S&P 500 performance (comparable to the one over the past year) occurred during the Asia and Russia crisis of 1997/98. The current underperformance of Oil to the S&P 500 is not just one of the largest on the record, but is by far the longest one. Given that divergences of this size closed in 10 out of 10 historical instances, we believe a closing of this gap is very likely.


This can occur either by the S&P 500 falling (e.g. Oil is a predictor of a recession, as in 2008), or by Oil rising (e.g. a reduction of speculative positions, reduction of supply, geopolitical escalation). In any case, we believe that a long Oil and short S&P 500 trade is likely to deliver positive performance in 2016.


A sharp rise in Oil prices could also trigger ‘stagflation’ and lead to an equity bear market. While markets currently estimate the probability of this scenario at less than ~3% (option-implied probability of, for example, Oil doubling and the S&P 500 declining), we think the risk of that scenario is much higher. What could cause a sharp increase in Oil prices? For one, we note that current levels of OPEC production are likely not economically rational or sustainable. For example, to justify an increase in production at a time when prices have declined from $100 to $30, one would need to place triple the production level without further impacting the price.


As geopolitics is likely playing a large role in the Oil price decline, we think it can equally lead to a sharp price reversal. In addition to an agreed production cut, production disruptions are an increasing risk in our view. Recent increases of tension between Saudi Arabia and Iran add to that risk. Parties to a conflict that could independently lead to such disruption include: extremist elements from Saudi Arabia or abroad (e.g. for recent attempt see here), Yemen (for recent attempt see here), Iran, and others. Moreover, high marginal cost producers may drop offline, reducing supply. A doubling of Oil prices may not be a tail event after all (e.g. a significant increase in Oil prices would also be consistent with J.P. Morgan’s current Q4 forecast).


To further assess the likelihood of an equity bear market, we look at historical bull and bear S&P 500 cycles over the past 50 years. We have identified 19 such cycles that alternated in relatively regular periods of time. There were 10 bull markets, lasting on average 4.3 years and delivering ~90% average returns, and 9 bear markets lasting on average 1.1 years and resulting in an average decline of 33%. The current ~205% bull market started in 2009 and is now 6.5 years old. As such, it is one of the longest/largest bull markets. There was only one longer and larger cycle, namely from 1990 to 1998 (that coincidentally ended with the Asia/EM crisis and sharp decline in Oil prices).


The length and return of a bull market is closely related to the size and length of the bear market preceding it (and vice versa). This is shown in the figures below which relate the return during a bear market (horizontal axis) and length of subsequent bull market (Figure 5), and return of the subsequent bull market (Figure 6). In that regard, the current bull market is in-line given the size of the 2008/2009 bear market. In other words, if the bull market was to end now and we are entering a bear market – it would be in-line with historical trends. While this analysis is not proof of an impending bear market, it indicates to us that the chance of entering a bear market this year is probably higher than 25% (currently implied by option markets).



Finally, for the end of a bull market, one needs to have equity prices ahead of their fundamental valuations. While valuation of the overall market is not consistent with a stock market bubble, some pockets do show stretched valuation (e.g. the market capitalization of Internet/Software sectors as % of the S&P 500 is not far from tech bubble peaks).


Figure 7 shows the level of the S&P 500 as well as short-term interest rates (Fed funds). Between 1990 and 2010, the Fed was adjusting short-term rates largely in synch with the price performance of the S&P 500. Historically, the Fed increased rates during market rallies and reduced them during market selloffs, in pursuing its dual mandate of maintaining price stability and maximum employment. This trend broke in 2009. As the US equity market took off, the Fed kept rates at zero and added large monetary stimulus over the next 5 years. This coincided with one of the largest and longest bull markets in US history. During this bull market, stock and bond buybacks increased in pace, with the Fed buying ~15% of government bonds outstanding, and corporates buying back about ~10% of stock outstanding, which were a driver of the increased asset prices. A clear break of the trend between Fed Funds and the S&P 500 might imply that either the S&P 500 rallied too far given the weak growth and appropriate Fed stimulus, or that the Fed underestimated the strength of the economy, in which case the stimulus would have contributed to inflating a bubble. In any case, an increase of short-term rates could be a catalyst for a correction, or even the start of a bear market.


In case an equity bear market materializes this year, investors should benefit from increasing allocation to cash or gold. Cash has zero correlation to all risky assets, while Gold has recently exhibited strong negative correlation to risky assets (e.g. -40% to equities). While bonds have historically been an efficient portfolio hedge, we think that bonds are increasingly at risk of becoming positively correlated to equities (e.g. selling of EM reserves, systematic strategies de-levering, or interest rates increasing).

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hedgeless_horseman's picture



Now that the latest Audit the Fed bill has failed, JPM has a bluelight special going on puts.

Tarzan's picture

This Quant is clearly not in sync with his boss, Jamie.... Mr Look at the size of My wallet, all is well!

Scooby Dooby Doo's picture

Nothing 'Startles' my dogs on ZH!

A rhoo-rhoo-rhoo Scooby Doo!

prefan4200's picture

It is 3:15PM.  The PPT should be walking in the door any minute now.....

Nobody For President's picture

The PPT said the hell with it and stayed in the bar - *somebody* has to teach Mr. Yellen a lesson.

Pinto Currency's picture



No way to predict a bear market?

How about central bank loose money for a protracted period.

Cut-off loose money.

= Bear Market 100% of time.

Ruffmuff's picture

When all the money is lost on stock shelves, then it will be a bare market.

ThanksChump's picture

Go to any store that isn't large enough to warehouse their goods.

Look at the shelves where import-reliant dry goods usually sit.

It's surprising to see empty shelves already.

pickatheweek's picture

Planet Earth is blue
And there's nothing you can do

Wulfkind's picture

Ground Control to Major Tom

You algo's dead, there's something wrong

Can you hear me Major Tom

Can you hear me Major Tom

S5936's picture

"Take your protein pills and put your helmet on" ...and run for the hills !!!!

Fuku Ben's picture

They've already finished serving their friends and fraudsters in high places. Maybe some of the morally obliged banksters feel the need to offer a few table scraps of information to the muppets on their way back to San Jose.

TideFighter's picture

Gold has recently exhibited strong negative correlation to risky assets (e.g. -40% to equities)

Who knew?

Tarzan's picture

The price of paper gold means nothing!

For the stacker, physical Gold and Silver are not investments, they're insurance, a hedge against a crashing Dollar.  The day will soon come when insolvent Washington can't even pay the interest on their debt.  The Dollar is making a gasp, a last minute surge, before it's destroyed.

When the Dollar falls you will see the fire works in Precious metals prices!

jakesdad's picture

"Gold and Silver are not investments, they're insurance"



Ness.'s picture

Goldbug here but I have to amend your statement.  Gold/Silver in your hands are most certainly investments.  Paper PM's are trading vehicles.  


Keep stackin' 

savedeposit's picture

The sombrero manipulation pattern is forming in the silver chart AGAIN

Another day of more lies and bull shit

Tinky's picture

Gotta tip your hat to them.

WTFRLY's picture

One might wonder if some of these tidbits are written specifically so they end up on ZH. Maybe not in this instance, but good to keep in mind.

Rainman's picture

Reach further down this rabbit hole and you'll find QE4

Consuelo's picture



Only a matter of time + acceleration of decline.     Hey...  Maybe somone can sketch that out as a math problem...?

TheDanimal's picture

Where's my damn helicopter money?

HardlyZero's picture

Anybody have a bootstrap out of this hole ?

When is the kicker going to end this Matrix Inception ?  (triple-entendre)

Vlad the Inhaler's picture

 QE artificially inflated asset prices as we all know, but buyers who just got super burned by the crash are not going to be ready to jump back in to that bullshit just yet.  Aka their credibility is fading and they are almost out of bullets.

Dragon HAwk's picture

Another Big bank telling us things are going to Crash.

 I swear it's like somebody changed the music and the lighting in the Cigar Lounge

surf0766's picture

Is 1900 the line that must be held?

BadLibertarian's picture

Just saw 1899 flash by, then back to 1901. Paging Dr. PPT, Dr. PPT to the emergency room.

BadLibertarian's picture

That's where it just bounced. Next we'll see if there's a ramp into the close or more collapse.

ToSoft4Truth's picture

At least we get warned in advance this time. 

jakesdad's picture




s&p close?


paging dr pluge protect - dr phunge protect please report to er stat!

two hoots's picture

When reality and self fulfilling prophecy meet......

katchum's picture

The gold bugs just got a new ally Gandalf.

Temporalist's picture

"Look to my coming on the first light of the fifth day, at dawn look to the east."

ParkAveFlasher's picture

Rohan's war cry:  "Gold, bitchez!"

Insurrexion's picture



How about this guy's prophecy that global credit (sovereign debt) will implode?

Gambit's picture

Stop spaming this man... although a good read, stop the spam. 

Jack Burton's picture

Anyone else see this today in UK papers:

'Sell everything!' Dire warning from Royal Bank of Scotland as fears mount that markets are set for new crash and oil could plunge to $10 a barrel
  • RBS tells investors 'In a crowded hall, exit doors are small. Risks are high'
  • Mass sell-off could be as severe as the 2008 market meltdown, bank says
  • Oil price drop could see petrol fall to 86p a litre, says RAC 

In a gloomy report, RBS analyst Andrew Roberts said. ‘Equities have become very dangerous. Watch out. Sell mostly everything… The game is up. The world is in trouble.’

In its note to clients, the bank warned that ‘this all looks similar to 2008’ when the collapse of US banking giant Lehman Brothers triggered the global financial crisis. Mr Roberts advised investors to switch their money out of risky assets such as shares and into the safety of bonds."

RBS is a ward of the UK taxpayers. I wonder what game they are playing here.

froze25's picture

Read about it yesterday.


Fred 'the shred' neglected to provide 'Informed Consent' to clients of RBS on the last 2008 implosion of Subprime Housing Loans, and the derivatives knock on destruction. This time out the cocksucking lawyers have decided that forewarning of impending disaster on the economic front is fiscally prudent in the long run of adverse affects on litigation costs. Ergo, the mofos decided to act in terms of fiduciary duty to warn so they would not have to sit through litigation for the remainder of their pathetic lives. In brief, the time for playing games is long up for RBS due to their collective incompetence to lead that bank in a professional manner back in the last crash. And as a ward of the taxpayer it cannot fail to inform their current clients of impending disaster ahead.


Sell _EVERYTHING_ actually means what it states this last round of civilization.

Trucker Glock's picture

Wake me when there's a 95% chance of a 50% decline.

SoDamnMad's picture

PPT is warmed up and ready to BUY STAWKS.  LOTS OF STAWKS.  Maybe not green but we will turn this Titanic around before that icy thingy is hit.

Jack Burton's picture

"Buy stawks and green shoots will appear", B. Benanke

E.F. Mutton's picture

Dogs and Cats, living together...

HardlyZero's picture

Young Americans and Diamond Dogs, waiting for the Panic in Detroit.