Bob Janjuah: "In One Year I Expect Global Equities To Be 25%/30% Lower; The S&P Will Reach Low 1000s In October"

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Nomura Bob is back with another hotly anticipated if, unfortunately, grammatically flawless, market strategy piece. Short and sweet, Bob as usual cuts right to the point.

Bob's World - Still overreacting?

Summary

Most commentators now seem to accept that what is happening is not an overreaction, rather the markets are at last on the way to fully pricing in the sad state of the global economy and global markets. I remain firmly convinced that we are in a secular bear market where stage 1 was the late 2007 to early 2009 sell-off, stage 2 was the countertrend rally from early 2009 to April 2011, and stage 3 is the current phase, where I expect the sell-off to last at least until late 2012.

The key basic problems remain weak trend growth in the DM world, which we think will continue for another three to five years, the policy errors (in our view) of the current set of policymakers, and the existing set of inadequate 'old world' policy institutions.

My secular view remains bearish. In or within a year from now I expect global equities to be 25% to 30% lower. My S&P500 target for the low in 2012 remains 800/900, and I think an 'undershoot' into the 700s is entirely possible. In this bearish outcome I would expect 10-year bund yields at 1% to 1.25%, 10 year UST yields at 1.25% to 1.5%, and 10-year gilts below 2%. The USD should do well, credit and commodities should not.

My view over the next month also remains unchanged. I expect stocks to reach their lows for 2011 in this time frame. I still expect the S&P 500 to bottom in the low 1000s in October. And I expect to see 10-year bund yields below 1.5%, 10-year UST yields below 1.75%, and 10-year gilts close to 2%. Beyond October 2011, on a two- to three-month basis into year-end/early 2012, I still see a possibility of a decent counter-trend risk rally. Should this materialise, the S&P500 could move from a low in October of around 1000, up to/towards 1200 by end-December 2011/January 2012.

On a secular basis, investors should remain cautious, and focus on strong balance sheets and strong/robust business models. I expect the next year to be about capital and job preservation. Any counter-trend rally should be tradable but short lived - it should be viewed opportunistically.

And the Full report

My last report (Bob's World: It's only just begun) was published on 23 August. A month on I have little to add as markets and data are evolving almost exactly as expected. Most commentators now seem to accept that what is happening is not an overreaction, rather the markets are at last on the way to fully pricing in the sad state of the global economy and global markets. It may sound repetitive, but I remain firmly convinced that we are in a secular bear market where stage 1 was the late 2007 to early 2009 sell-off, stage 2 was the countertrend rally from early 2009 to April 2011, and stage 3 is the current phase, where I expect the sell-off to last at least until late 2012.

Basic problems

The key basic problems remain weak trend growth in the DM world, which we think will continue for another three to five years, the shocking policy choices of the current set of policymakers, and the existing set of woefully inadequate 'old world' policy
institutions.

Growth

The consensus now appears to be moving towards the kind of weak trend growth outcome Kevin and I have been highlighting for some time, with trend DM growth expected to be around 1%pa over the next 3 to 5 years. For now, however, EM and thus global growth outlooks remain 100-200bp too high on a three- to five-year trend basis. Expect these to also be revised lower over the next few months. Decoupling may come one day, but we doubt it will happen in the foreseeable future.

Policy errors

More and more people seem to be coming around to our view that policymakers (globally, not just in the euro zone) have made some major errors in terms of diagnosis and treatment of the crisis. And they now seem to judge that responsibility for these policy errors lies not just with politicians, but also with central bankers. The policy errors are continuing, in our view, and look likely to do so until 2013. Even the consensus now sees the limits to credible policy, and can see that those limits either have or will very soon be exceeded. In 2012 I fully expect current policymakers to be revealed as „emperors with no clothes.?

Still bearish

It is for these reasons that my secular view remains bearish. In or within a year from now I expect global equities to be 25% to 30% lower. My S&P500 target for the low in 2012 remains 800/900, and I think an 'undershoot' into the 700s is entirely possible.

For the valuation-focused, assume S&P 500 EPS in 2012 of $90/$100, and P/Es in the 8 to 9 area – I see this kind of P/E as the new norm in the kind of world we are in. In this bearish outcome I would expect 10-year bund yields at 1% to 1.25%, 10 year UST yields at 1.25% to 1.5%, and 10-year gilts below 2%. The USD should do well, credit and commodities should not.

Here I have to insert an important caveat regarding Germany and bunds. My core assumption remains that in the euro zone policymakers DO NOT attempt to fix an excess leverage and low growth problem with MORE leverage! This type of plan obviously appeals to Tim Geithner, but the core euro zone should be extremely concerned by the suggestion that leveraging the EFSF is a supposed „solution?. And of course Germany should also be deeply concerned about de facto attempts to force the ECB to follow the Fed into unsterilized monetisation. Germany/the core euro zone are simply NOT the same as the US and should not attempt to follow a policy which, frankly, has in any case failed in the US!

Short-term view

My view over the next month also remains unchanged. I expect stocks to reach their lows for 2011 in this time frame. I still expect the S&P 500 to bottom in the low 1000s in October. And I expect to see 10-year bund yields below 1.5%, 10-year UST  yields below 1.75%, and 10-year gilts close to 2%.

A counter-trend risk rally

Beyond October 2011, on a two- to three-month basis into year-end/early 2012, I still see a possibility of a decent counter-trend risk rally. Should this materialise, the S&P500 could move from a low in October of around 1000, up to/towards 1200 by end-December 2011/January 2012. I see many possible drivers of this risk squeeze: Greece could be bailed out through to early 2012, which is when I would expect it to default and the restructuring of the euro zone to begin in earnest; Kevin expects a two- to three-month patch of „better? data in Q4 2011; QE2 in the UK; ECB rate cuts; positive EFSF headlines or progress; positive PSI headlines or progress. At least part of President Obama?s fiscal 'boost' should happen, and something is better than nothing. Additionally, should the S&P 500 hit the low 1000s (over the next month or so, as I expect) and the unemployment rate exceeds 10%, I believe the Fed will be unable to resist another dose of QE, whereby QE3 will be a rehash of QE2. Finally, I think positioning and sentiment by late October 2011 will be such that markets are ripe for a decent squeeze.

Of course, we may not see all or even any of these drivers, but in terms of the squeeze better in risk into year-end, only some would need to materialise. In terms of the bigger picture, however, I am sure that even if all of these drivers were to occur together over Q4, the net result would be nothing more than a short-term boost primarily to the paper value of risk assets in markets, and a boost to commodity prices. In the long run I would see QE3 (which is a redux of QE2) as an even bigger mistake than QE2, and in the context of the euro zone, I fully expect policymakers to remain badly behind the curve on substantive matters (mere word, hope and unfulfilled promises are very counterproductive).

Stay cautious

On a secular basis, investors should remain cautious, and focus on strong balance sheets and strong/robust business models. I expect the next year to be about capital and job preservation. Any counter-trend rally should be tradable but short lived – it should be viewed opportunistically. My core message is bearish. Over the past month Kevin and I have looked closely for anything that could change our view and have come up with nothing. Even the hope that EM or China can go on a multi-trillion USD investment binge to re-ignite global growth seems pretty forlorn, as China?s last fiscal and credit binge in 2008 is proving very costly to clean up. The euro zone may positively surprise us with a clear and credible plan for the region, involving major debt and economic restructuring for Greece, Portugal and Ireland, a major recapitalisation of the euro zone financial system, and the formation of a „neue-eurozone? with a hard-money ECB at the core. We can but hope. The only alternatives are immediate full fiscal union, or full on unlimited unsteralised monetisation by the ECB. Both „options? are I think extremely unlikely.

The Geithner plan

Finally, a quick comment on the „Geithner? plan for the euro zone, which proposes leveraging up of the EFSF and which ultimately relies on (not so) stealth unsterilized monetisation, without any control, by the ECB. The aim of this plan seems to be to extend the global debt “ponzi” for as long as possible, through financial alchemy by essentially boot-strapping a highly levered CDO onto the euro zone?s debt burden. We see major execution risks associated with this plan, and there is significant opposition to it already in key parts of the euro zone. Importantly, if this „plan? were ever implemented, then, when it inevitably fails - I feel this plan would be even more negative for private sector growth in the euro zone than is the case currently, and this growth weakness would totally undermine this „plan? - the eventual damage done to both the system and the real economy would dwarf the current burden that needs to be borne in order to put the euro zone onto a stable path again. And bearing in mind the highly problematic debt, deficit and economic situation in the US, which will take centre stage as the market worry in 2012, then a proverb about glass houses and stones springs to mind.