A mere three weeks ago [9], Nomura's Bob Janjuah forcefully suggested that complacency warranted a tactical risk-off position given the misplaced confidence heading into the plethora of event-risk ahead. It seems, 60 points later, that he is on to something; but this time he is more critically concerned: "Investment decisions based largely on the greater fool theory and predicated by the assumption that central bankers can sustainably and credibly misprice money, supporting a significant misallocation of capital, without any major negative consequences, are in general not good investments."
Via Nomura's Bob Janjuah:
My most recent note was released on 24 September [10] and herein I provide an update. I also refer readers to my colleague Andy Chaytor and his most recent Top Macro Trades note released on 23 October. The Global Macro Strategy team has not published much in the last two months, largely because markets have unfolded very much along the lines we set out earlier in September and August, where I set a weekly closing S&P500 level of 1450 as the key pivot point for markets. Following on from the big bazookas from Draghi and Bernanke in early September, which very briefly took the S&P up above my 1450 level on a weekly close (hence triggering my stop loss [10]), the market has performed far short of the bullish expectations of most market participants. Ever since early September and the 1475 intra-day high print on 14 September the risk-on (carry) trade has disappointed. The S&P spent most of the following month sideways around 1450, and since mid/late October sideways risk markets have given way to a risk-off phase [9] in which credit spreads and equities have underperformed, as have peripheral bonds, and core bonds and the USD have outperformed. This is all very much against the bullish sentiment that existed and that many have kept repeating to us post-OMT and post-QEI.
If I look out 6-18 months, during which lots can happen, my bias for markets in the long-term timeframe remains very bearish. I worry about excessive debt in the West, I worry about anaemic growth globally, and I worry about both the market?s Pavlovian fixation on continued (but increasing unsuccessful and non-credible) policy stimuli and on the willingness and ability of policymakers to actually continually deliver/surprise to the upside.
If I look out 3-6 months I am open to the idea of one last parabolic spike higher in risk-on markets in this interim timeframe. I think we will eventually get fiscal and debt ceiling fudges in the US. Of course long-term credible solutions are needed, but are the most unlikely outcome. Instead we may well be 'forced' to celebrate another round of horrible fudges which DO have a consequence. Namely, that the private sector continues to ignore Bernanke and the Washington elite (who between them continue to enjoy printing significant sums of money and/or spending way beyond their means ) by instead doing the exact opposite, which means holding onto/building cash and savings, delaying spending/investment/hiring and thus hurting growth. Markets will I think worry about these negative consequences eventually (see paragraph above), but in the interim the knee jerk reaction of markets to fiscal/debt ceiling fudges will likely be positive.
Furthermore, and again on a 6 to 12 month interim timeframe, I think we could also see the ECB finally move to all out QE driven by another round of eurozone panic and driven in particular by the strong deflationary data trends that are emerging in the eurozone and which we in GMS think will get much stronger. A combo of ECB QE and fiscal/debt ceiling fudges in the US – perhaps also complimented by a short-lived centrally planned but debt fuelled and ultimately wasteful China uptick – could even cause a parabolic spike powerful enough to take S&P – briefly – into the 1500s, before resuming the longer-term march over the rest of 2013 and 2014 to the 800s.
Our secular investment bias for the last four years has been to overweight strong balance sheet non-financial corporate credit, and to overweight the largest and strongest balance sheet non-financial corporate equities. This secular bias will change eventually, but for now we doubt whether such a shift will be worthwhile until perhaps 2014. Until then, and in the absence of major new developments, we stick with this secular theme, which on a risk (Sharpe ratio) adjusted basis has proven to be the winning secular investment strategy over the last four years.
For the rest of this year (0-3 months), and with the S&P trading well below my 1450 pivot point, I remain bearish on this short-term timeframe. Based on weekly closes in the S&P below 1450 we went bearish risk (having been stopped out in September [10]) in mid-October (see Andy's note [9]) and we reiterate this view herein. So that also means we have been and are long the USD and core bonds, and we have been and are short not only global equities, but also peripheral debt and credit spreads. With respect to this short-term timeframe we also reiterate the stop loss at 1450 (S&P weekly close) and the 1450/1475 pivot point below which (on a weekly S&P closing basis) we are bearish and above which we see more upside on a tactical basis. I would also highlight in particular that, based on extensive client meetings, a real sense of complacency and/or fatigue has set in with respect to the rest of 2012 (most participants continue to talk a bearish 2013 when they meet with us, although it seems quite clear that true sentiment is much more hopeful). There is an overwhelming belief (or a deep desire to believe) in markets that all major risk factors have been successfully pushed out to 2013 by policymakers. It is clear that the market is not expecting nor is positioned for a big reversal in say the S&P500 down to 1300 and all else that such a move would imply. In particular, fast money has got itself long risk in an attempt 'fix' a poor year for overall returns, but must now be getting anxious that follow-through price action and buying has been deeply unimpressive. If fast money decides/is forced to cut risk this year, bearish price action could easily be exaggerated relative to volumes, as neither the Street nor real money has much appetite and/or capacity for risk between now and year-end.
As a team we are debating whether to lower our stop loss from 1450 to perhaps 1400. For now we stick with the stop loss that has served us so well. Also, there may be merit in taking profits on the risk-off trade we reinstated in mid-October when the S&P had its sub-1450 weekly close (1440) as/when the S&P500 trades down to 1350. But again, for now, we will continue to focus on 1300 as an initial major target.
Some comments on complacency and fatigue. The last few years have been difficult, especially for those that have been unprepared for how long and difficult the current crisis, which began in 2007, would be. However, as a rule, growth and earnings, incomes and jobs, and deleveraging and balance sheet trends matter. They may not all matter all of the time. But on virtually any timeframe beyond the highly tactical, and in any case whenever large pools of client money are being managed, such key items matter a great deal. Which is why I am so concerned at the number of times I have heard from participants that growth and earnings, and/or jobs and incomes, and/or debt and deleveraging now no longer should matter that much as Bernanke and Draghi will make it all better. I am the first to point out that we are living in a policymaker-fuelled bubble that will likely end very badly, where normal valuation metrics are largely meaningless.
But even if we are in a bubble, as a golden rule one should never lose sight of what matters in the real economy and in the long run. Namely: growth and earnings, jobs and incomes, and debt and deleveraging.
Investment decisions based largely on the greater fool theory and predicated by the assumption that central bankers can sustainably and credibly misprice money, supporting a significant misallocation of capital, without any major negative consequences, are in general not good investments.
Look at what has happened since mid-2007 until now, the last time this type of 'investment thesis' was exposed! Back then policymakers told us there was no housing bubble, and were asleep at the wheel when it came to the significant leverage bubble that banking and finance had become. Now of course Bernanke and his ilk are trying to convince us that QE is a good policy and that we should trust them to do the right thing at the right time to head off any new bubbles or the take-off of inflation. What else should we expect? Personally, I have little confidence in policymakers, based on their track record.