Citi's Matt King: "We Think You Should Sell"

Tyler Durden's picture

With spreads at post-crisis tights, equities making new highs, and new issues oversubscribed, markets are clearly exuberant. But could it be rational this time? We’re not convinced.

      - Citi's Matt King

In a surprisingly bearish report, Citi's Matt King has issued a new, long-awaited note in which he asks rhetorically "what’s a manager supposed to do when by early March your asset class has already exceeded your expectation for full-year returns? Take profit and take the rest of the year off, of course! And if it carries on rallying, go outright short!" And yet, he adds, "somehow nobody seems to want to." The reason for that, according to King is that as we showed demonstrated last week using JPM and BofA data, "the rally owes more to inflows and short covering than to institutional investor exuberance. And part is that the economic data do seem genuinely to be improving."

Nonetheless, King's assessment of the current environment is downbeat and to the point: "sell we think you should, not only in € credit (as we advised a couple of weeks ago) but also more broadly."

He then lays out seven reasons "not to trust your inner Trump", which are as follows:

1. The Fed may stop the inflow party

The Citi strategist begins by noting that "perhaps the best reason to remain long is that institutional investors seem not to be." He adds that the vast majority of the FI investors we have seen in recent weeks still believe in secular stagnation, and further notes that "to judge from our survey, overall positions have been creeping longer, but this is due overwhelmingly to positions among $ investors: those in € and £ credit have actually been falling (Figure 1)."

King joins the strategist bandwagon pointing out to the source of recent inflows and states that "the principal driver of investors’ buying seems to have been a response to mutual fund inflows. Not only equity funds but also bond (including both credit and EM) mutual funds have had their biggest 4-week run of inflows since 2013 (Figure 2). Numbers in Europe have been slightly weaker than the US-dominated  global totals, but the pattern is similar."

There is a problem with that: "But while this too might normally be a reason for bullishness, we doubt that the current pace is sustainable."

Quite apart from the historical inability to maintain this flow rate for long, there is the small problem of the Fed. While at this point a hike on March 15 has been so well telegraphed that it ought not to cause a 2013-style tantrum, we do think much of investors’ willingness to pile into risky assets stems from the lack of return on cash. Each and every additional bp in risk-free yield is likely to make investors think twice about the risk they are running in order to generate return elsewhere.

It is also worth noting that over the past two weeks, BofA has caveated that while retail inflows are seemingly relentless, institutions and hedge funds have recently turned sellers into the rally, and are aggressively offloading to retail, traditionally a market-top indicator. 

2. A rise in real yields should weigh on risk assets

King's second reason why he thinks the rally has been so strong is that real yields have remained surprisingly low. Even as nominal yields have risen since the US election, almost all of the action has been in inflation (and growth) expectations (Figure 3). Traditionally this is positive for risk assets; in contrast, when real yields rise, it weighs on risk assets – albeit sometimes with a lag (Figure 4).

Citi suspects that what has made this move possible is the market’s willingness to focus on all the potential growth positives and yet shrug off the increasing signs of hawkishness from the Fed. "Such a position seems increasingly untenable on two counts. First, rates markets have now finally adjusted to the new mood music from the Fed, and seem increasingly likely to be confronted with an actual hike; second, the rally in credit was starting to look out of whack even with today’s real yield levels, never mind following any proper adjustment to follow."

3. Central bank support is set to diminish

While it is no secret that King has long been a closet adherent to Austrian Monetary Theory, in his latest piece King reminds regular readers that one of his favourite model for markets’ behaviour in recent years is their correlation with central bank liquidity. While the scale of their purchases over the past half-year or so has been close to record highs, it is already diminishing, and set to diminish further (Figure 5).

He brings attention to BoJ purchases, which in recent months have almost halved since their shift to yield targeting; furthermore ECB purchases will be reduced by one quarter from this month on. In EM, FX reserves have held up well since February last year, and in recent months have been propped up as EM portfolio inflows have gone a long way towards offsetting a worrying trend towards net FDI outflows.

But this too we suspect was aided by the Fed being on hold, and is liable to face renewed pressure as it returns to rate hikes. Besides, the extent of the rally once again seems excessive even for today’s level of CB purchases, never mind relative to its likely future trajectory (Figure 6).

In short, absent a material shift in central bank posture, the traditional driver of risk asset upside will be gone for the foreseeable future.

4. It’s the stimulus, stupid

And then there is China. 

As a recent NY Fed report pointed out, "China Accounts For Half Of All Global Debt Created Since 2005." This echoes what we have been writing about for years, starting back in 2013 showing "How In Five Short Years, China Humiliated The World's Central Banks", when we showed that in just the brief period since the financial crisis "Chinese bank assets (and by implication liabilities) have grown by an astounding $15 trillion, bringing the total to over $24 trillion. In other words, China has expanded its financial balance sheet by 50% more than the assets of all global central banks combined."

This, too, is a worry for the Citi strategist, who writes that "continuing with the idea that market strength owes more to a wave of technical support than to fundamentals, we remain convinced that the recent explosion of credit in China – visible in the monthly total social financing numbers – is of greater global significance than is widely recognized."

King posits that while it is hard to prove empirically, at an anecdotal level almost every place you visit from San Francisco to Sydney seems to be awash with stories of Chinese investment propping up prices. While most of this is in real estate, King thinks the effects of credit creation spill over from one asset class to another, and increasingly from one region to another also.

The punchline: "fully 80% of the world’s private sector credit creation at present is occurring in China. The evolution of this global total bears at least a passing resemblance to global asset prices (Figure 7)."

Which leads us to the $64 trillion question: is this pace of credit expansion sustainable? Citi's answer: "we rather doubt it."

Chinese numbers tend to reach a seasonal high in January as new lending quotas are granted but then to fall off sharply thereafter. And the positive impulse from the recent acceleration in credit creation in China will in any case be hard to sustain just because the absolute rate of growth is already so high. If anything, the recent tendency towards renewed FX outflows – even in the face of tightening capital controls – speaks to a reduction in demand for investment in China itself (Figure 8), itself encouraged by a series of measures designed to introduce brakes on lending, in the property sector in particular. To our minds the wave of recent strong data in China, and associated run-up in many commodity prices which has itself fuelled optimism about a global reflation trade, owes less to a durable upswing in growth – and more to an unsustainable temporary resurgence in credit – than has been reported.

At this point it is worth reminding readers of a recent note from UBS which likewise looked at the global credit impulse and found that it had "suddenly collapse to negative", primarily as a result of an annualized slowdown in Chinese credit creation.

There is some hope that US or DM credit stimulus would be able to take over even if Chinese stimulus wanes – and indeed, exactly such a hope would seem to be one of the drivers of both the rally and the improvement in much DM survey data. The hope here is that abnormally high savings rates in various developing nations would propel a spending surge. However, King then quickly shoots down the suggestion saying that such an alternative source of credit creation "seems unlikely." His skepticism is borne from a simple problem of scale: "Corporate balance sheets are already highly levered. Besides, the sheer scale of Chinese borrowing – $3tn/year relative to a mere $800bn in US and Europe combined – makes it difficult to see how these could substitute."

5. Just how strong are growth prospects really?

To provide a counterpoint to his bearish points, King then asks "what of the counterargument to all this, namely that markets are merely responding to a marked pick-up in global growth prospects, sending secular stagnationists like ourselves scurrying for cover and raising the prospect of a longawaited return to ‘normal’ growth?" He admits that there has been a pickup in both growth and inflation data, and indeed in corporate earnings. And we do buy the argument that, while corporate capex has been weak relative to profits and to GDP, in outright terms it is not perhaps as moribund as pessimists (ourselves included) sometimes make it sound.

Alas, for the Citi strategist, this may be as good as it gets when it comes to global growth, which as DB warned several weeks ago has already started to revert lower, and furthermore as we have been pounding the table for weeks, the improvement has been mostly focused in "soft", survey-based data:

We are much more skeptical of the likelihood of a continued and self-reinforcing cycle of growth from here. Economic surprises have a natural tendency towards mean reversion and in the US are already starting to come down. A number of commentators are starting to point to the fact that the improvement in economic numbers is heavily skewed towards survey data as opposed to actual production and consumption numbers. US jobless claims at 40-year lows in any case suggests that further hiring may begin to contribute more to inflation than to real GDP

Meanwhile, on the corporate side, while leverage has been declining, recent reports fail to show any evidence of significant revenue growth – one of the vital missing ingredients that could conceivably lead to an acceleration of capex (Figure 11). Perhaps revenues were crimped by $ strength, but overall this suggests that the EPS growth everyone is getting excited about owes more to further cost cutting and perhaps currency moves (helping explain why the pick-up is greater in Europe than in the US) than it does to anything that will sustainably buoy the economy.

As King notes, the market internals already point to this:

Sadly, there are even signs that the equity market itself recognizes this likelihood. While the S&P has continued to rally at a headline level, our equity strategists have pointed out that it is again being driven by defensive sectors, not cyclicals – something historically more consistent with a rally in Treasury yields and a global reach-for-yield than with a growth-led reflation

And then there is the political front: Citi writes that its take on the Trump speech to Congress – with its repeated reference to infrastructure spend but general lack of detail – is that prospects for widespread fiscal reform remain so contentious, even among Republicans, that the likelihood that they drive a significant near-term boost to growth is actually dimming. "Once again, this suggests that markets may be getting ahead of themselves."

6. The beast that refuses to die – European political risk

And then there is Europe, and especially France where over the past few days, the market promptly assumed that any Le Pen risk overhang has been eliminated. Not so fast, according to King:

To judge from the recent rally in OATs, you could be forgiven for thinking that Macron had been elected already, and that euro break-up risk was once again off the table. Without wanting to get too involved in the labyrinthine twists and turns of what is already turning out to be a decidedly antagonistic campaign, we doubt very much that this risk is gone for good.

Citi then highlights four factors which keep it convinced European periphery risk and French domestic-law bonds are still a ‘sell’ here – and that renewed periphery widening may yet upset markets more broadly.

  • First, we still think there is the potential for significant nervousness among real money investors in the run-up to, and immediately after, the likely first-round Le Pen victory. Notwithstanding demand from domestic institutions for bonds that others wish to sell, experience suggests that there is nevertheless a point where domestics become full.
  • Second, we still meet too many investors convinced that the ECB will somehow come to the rescue, or even that the market would shrug off a Le Pen victory in the same way as it did Brexit. We could not disagree more strongly.
  • Third, even a Macron or Fillon victory seems unlikely to us to consign European political risk to the dustbin of history in the way some have been arguing. Populists everywhere still feel as though they are in the ascendant – just look at the disarray among Democrats in the US, or the heated response to Sir John Major’s and Tony Blair’s stands on Brexit in the UK.
  • Fourth and most persuasively, almost regardless of what you think the actual probabilities of euro break-up are, we still see too little by way of premia across markets to compensate investors for the potential risks. Central banks appear to have succeeded in squashing the volatility and fear out of markets without removing the underlying risk factors themselves. The more markets rally, the greater is the potential vulnerability.

7. Finally, Valuations

Last but by no means least, King brings up the most sensitive topic for the market: massively stretched valuations. His rhetorical question is simple: "Do you really want to be buying credit at post-crisis tights, or the S&P at a cyclically-adjusted P/E which has been exceeded only in 1998-2000 and 1929?"

He then notes that the "only metrics on which € credit does not look expensive in our regular Valuations Report are those that are survey-based" and cautions that to the extent that investors want such upside, "we think they would be better served targeting assets that rallied less hard in the first place – albeit in small doses. And yet there, too, our outright inclination is more towards reduction and waiting for a better entry point than towards adding at current levels."

King's Conclusion

Having taken a several month sabbatical, the bearish Matt King is officially back: "To sum up, markets seem increasingly to be pricing all of the upside and none of the downside. When there was a risk premium in spreads, and when a wave of central bank and private credit creation seemed likely to carry everything tighter regardless of underlying fundamentals, we were happy to run with that. But we think that risk premium has long gone, and that markets’ strength owes more to those technicals than is widely recognized."

And a farewell anecdote from the bank's leading strategist:

When in the days of the Roman Republic generals were awarded the highest honour the Senate could bestow – the right to lead a “triumph”, or parade of the spoils of war, into the city – it is said that a slave was required to stand at their side and whisper constantly into their ear that they too were merely mortal. With the Ides of March approaching – and, rather neatly, coinciding both with an FOMC meeting and with the Dutch elections – we think the timing would be good for investors too to remember to what they owe their improvement in fortunes. We don’t think it’s the arrival of a new emperor.

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cossack55's picture

Someone must want to buy tho, yes?

knukles's picture

Stop thinking about it; you'll grow hair on the palms of your hands.

max2205's picture

I'll sell when Citi gets kicked out of China 

prime american's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... http://bit.ly/2jdTzrM

TheRideNeverEnds's picture

Recovery Summer VIII: Risk Addiction

booboo's picture

the market rewards the Risk ta.................insane.

buzzsaw99's picture

so i should buy the snapchat ipo asap?

booboo's picture

You bought Facebook out of the gate right? You are insane and sitting pretty, you crazy little bastard.

CPL's picture

Totally, should cash out all your savings and put a second mortgage on the house then go all in.  Totally worth it.  What does snapchat actually do btw?

BorisTheBlade's picture

Mortgage your kidneys while you are at it.

Snapchat produces something, I forgot what exactly, should be somewhere in the footnotes of the placement memorandum.

Though it sounded like they are out to change the world dramatically, so I assume they have a cold fusion tech finally figured out.

GooseShtepping Moron's picture

I've got all my savings in Cheez-its and green M&Ms. I should be okay.

blueberry100's picture

 

what's that deal abut Hogs getting rich or was it slaughtered --- ahhh

devo's picture

1. Why would I give a shit what Matt King thinks? I wouldn't.

2. Why would he have any incentive to give me good advice for free? He wouldn't.

charlie303's picture

Martin Armstrong says Dow 23,000 as money flows into a free America.

newmacroman's picture

Uh, that'll be the third Thursday of April.

25k at the end of May, sell and go away.

Chippewa Partners's picture

The wall of worry goes vertical. Buy 'em and they go up. Too easy!

Dragon HAwk's picture

I'm waiting for it to go alot higher before i Jump In.

Anarchyteez's picture

How presumptuous to presume anyone knows where the robotraders are taking us.

jamesmmu's picture

I trust you if DOW start in red for 5 days.

Giant Meteor's picture

Well maybe, but that door be crowded ..

Ben A Drill's picture

So Snap Chat was the top?

xantippa's picture

It kind of makes sense. 

Giant Meteor's picture

No Kreskin here, but shit, if it ain't it ought to be ..

CardiacTrader's picture

See that is why I love Zerohedge.  They have an excellent article aobut the education system demise in the US because of the influence of Marxism (Frankfurt School) and then they drop the ball with their market articles.

 

But, once again, Zerohedge comes to save the day by their brilliant posters who have clearly identified Shepwave as the one reputable analyst left on Wall Street.  Hope everyone has a great week. I just read their updates for tomorrow. This week should be interesting.

ShepWave 

ShepWave IMPORTANT Updates for Monday Published.
by ShepWave.com
Posted: 3/3/2017 22:02 EST

 

Nice predictable action for the short term this week, once again. Identifying these recent patterns is what makes day to day trading fun and consistently profitable.

 

The recent trading range is going to end. Will it end with a higher sloped rally trend? or will it end with a drastic bearish reversal? The Talking-Heads on the famed financial channels keep missing the SELL-OFF. Remember it is not good to be guided by one's emotions and *desires* in trading and investing.

 

STAY OBJECTIVE!

 

TURN OFF THE CNBC!

 

 

Patience is sometimes the key. The markets have been in a range bound short to mid term trend for some time.  THIS WILL END.

In fact it could end sooner than what some are saying. The key is to watch the technicals.

 Log In at www.shepwave.com for Monday's IMPORTANT ShepWave Updates.

IMPORTANT NEW ANALYSIS FOR GOLD TRADERS: Gold has been extremely easy to navigate and profit from for mid to longer term traders for years now; see the new analysis and signals.

Click Here  and Click Here to see recent time stamped charts with markets calls. These are periodically changed to show the wide range of vehicles that ShepWave covers. 

  

IMPORTANT Pre-Market / Intra Day Update for Monday Published:

Get ready for an interesting week.

We are watching for some particular--and favorite--chart patterns, including a potential Island Reversal.

The key is to watch the wave patterns for the short term, and in particular pay close attention to the overnight futures and the market opens.

As usual ShepWave will be vigilant in notifying  you of any particular changes due to the overnight futures.

    

Log In at www.shepwave.com for Monday's Pre-Market / Intra Day ShepWave Update.

Irvingm's picture

The sad truth is that despite the above average intelligence of most on ZH, the Frankfurt school as well as the analysis of ShepWave is above the level of most on here. But a few will appreciate both. 

BitchesBetterRecognize's picture

Matt king: "we should sell......................... moar stocks, moar ETF, moar paper Gold & Silver, moar Bonds, moar derivatives, moar EVERYTHING to the suckers out there still buying into this bubble!!!  

Fake Trump's picture

Geopolitical crises particularly North Korea and South China Sea. Mad dogs like Kim and Trump will trigger an inferno. 

TheVoicesInYourHead's picture

Shitibank was awesome at calling the 2007 meltdown and not going bankrupt.

truthseeker47's picture

If Shittybank says sell, I'm buying more.

vesna's picture

I still do not see exponential growth in indices. This can last at least for 2 years more..

Rebellion97's picture

First Bac and now citi, and during financials best rally In years? Riiight

Rebellion97's picture

And who cares what happens in Europe , jus like the fear of trump had everyone shitting their pants before and look now trump rally.
No matter what happens in Europe after elections are over I bet on euro rally.

OverTheHedge's picture

An observation from Europe, then: I call peak Bitcoin! My reasoning is this: I had a telephone call this morning from Fonestar! I never knew he had a really cool Dutch accent, and works for a "Venture Capital firm working out of Chicago, Illinois". I didn't get the name of the firm, but it was early and I wasn't expecting someone to try and sell me Bitcoin over the phone.

If people are now cold-calling Bitcoin sales, either they are desperate to get out, and can't, or the market has gone bubble-icious, and can't be sustained. Either way, time to sell. How the hell did a US based investment firm a) get my name and telephone number in Greece, and b) think that I might be a good prospect?! So, peak Bitcoin, as I see it.

[You realise that it will now double in the next three weeks, don't you?]

Batman11's picture

Is it time for the markets to get a grip on reality?

The world is full of imaginary wealth and pretty soon it’s going to evaporate.

How much real wealth did those Tulip Bulbs contain in 1600s Holland?

Nothing’s changed.

Wealth – real and imaginary.
Central Banks and the wealth effect.

Real wealth comes from the real economy where real products and services are traded.

This involves hard work which is something the financial sector is not interested in.

The financial sector is interested in imaginary wealth – the wealth effect. Hardly any of their lending goes into productive lending into the real economy.

They look for some existing asset they can inflate the price of, like the national housing stock. They then pour money into this asset to create imaginary wealth, the bubble bursts and all the imaginary wealth disappears.

1929 – US (margin lending into US stocks)
1989 – Japan (real estate)

1999 – US (dot.com)
2008 – US (real estate bubble leveraged up with derivatives for global contagion)
2010 – Ireland (real estate)
2012 – Spain (real estate)
2015 – China (margin lending into Chinese stocks)

Central Banks have now got in on the act with QE and have gone for an “inflate all financial asset prices” strategy to generate a wealth effect (imaginary wealth). The bubble bursts and all the imaginary wealth disappears.

The wealth effect – it’s like real wealth but it’s only temporary.

Refer to fundamentals to distinguish between real and imaginary wealth in markets. It's what they are for.

All that QE has to go somewhere and it sure as hell isn't in the real economy as can be seen from the inflation figures.

 

“Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.

Did you check the fundamentals?

Most of that wealth is imaginary

Another regional indian.'s picture

Stcok market is like waves. Waves come forward and go back. Same with the stock market. Thinking that the stock market will always only go down because the waves go back is absurd. Waves come forward too. Same with the stock market.

You have to buy when its rising (if you want to make money in the market ofcourse) and sell when its falling.  

You think since the stck market crashed in 1929, it will crash now. But did you know the US GDP growth at that time was negative? It was actually contracting. Ofcourse the stock market would have ultimatley collapsed in a negative GDP growth economy. And it did. Instead today the US gdp growth is positive. It grew at +1.6 something. Its slowing down but it is still well above zero, unlike in 1929. Add to that, todays stock market doesnt depend in GDP growth like it did in 1929. Meaning, even if GDP growth is slow, the market can rise. 

And you think since this trader is saying 'sell' you have to sell. But there are traders who are also saying 'buy'.

Traders are human beings too. Meaning...they can be wrong too. Hence, never look at what human beings say about the stock market when it is actually rising. Never.

They will be wrong because they are human beings.

Instead...look at the general direction the market is moving.

Grandad Grumps's picture

Who is left to sell to the banks and their cronies? It is possible that this is what it was all about in the first place. The market is likely irretrievably broken and they have no way to fix it, so they take it essentially private instead.

aqualech's picture

The DOW chart reminds me of a famous parabolic NASDAQ chart. IOW, party like it's 1999. What could go wrong.
Honestly though, taking profits is OK, too.

JailBanksters's picture

If that's the case, then I thinks you should buy

 

Fed-up with being Sick and Tired's picture

The moment I thought, "METHINKS IT IS TIME TO BUY MORE" - - I read you post.