While the traditional Barrons' flock of sellside penguins advisors [8]is out and about, for the second year in a row predicting that, after being wrong on its consensus forecast for 2015 of double digit growth in the S&P500, the broader market will rise 200 points to 2220 by December 31, 2016...
[9]
... we are more inclined to go with the contrarian call by Prerequisite Capital Management [10]which believes that Treasurys (deflation), not stocks (inflation) are the way to go in 2016.
Here are their arguments why.
- Deleveraging has hardly started: Both in the developed world and Emerging Markets.
- Capital Misallocation & Oversupply: Caused by (a) the cost of capital being held too low for too long, (b) policies that have caused saving & investment (global current account) imbalances to persist much longer than they naturally would have persisted
- Demographic headwinds: Aging populations etc
- CAPEX peak and credit conditions tightening: Escalating credit spreads, lending officer surveys show tightening standards for Commercial loans
- Turn in the Earnings Cycle: Profits and margins starting to compress globally and in USA.
- Tide going out on Buybacks: Growing recognition of corporate irresponsibility
- Global Capital Flows shift: Material regime change in pattern of capital flows last 12 months potentially representing an unwind of the last 7-15 years, engendering instability especially in Emerging Markets (highly elevated risks of banking crises & other shocks in the seasons ahead). Global trade also weakening strongly.
- Prevailing expectations towards higher yields: ZEW survey related inflation and interest rate expectations at peak optimism, ‘late-stage’ bear market psychology towards key commodity markets still absent(with vicious supply dynamics still reinforcing to the downside particularly in energy and industrial metals)
- Velocity still falling (both structurally and tactically): broader liquidity still tightening globally (overwhelming liquidity supply)
- Speculative’ Positioning remains substantially negative towards Bonds: stronger ‘commercials’ persistent in multi-year accumulation of Treasuries. ‘Late-stage’ bull market psychology towards multi-decade rise in Bonds still absent(& under-owned)
- Geopolitical Escalation and increasing trade barriers growing at the margin.
- Fed & Central Banks backed into a corner: trapped by excessive reliance on low interest rate policies (last couple of decades) and QE (over the last 7 years), unable to unwind such programs due to the extreme fiscal constraints of both the public and private sectors.
And some charts why it is TSYs that Barron's "pundits" should - but won't - be pitching.
First, Tightening Lending Conditions, which according to Prerequisite means "we may possibly be about to see bond prices go much higher."
[11]
Then a rollover in margin, both profit and debt "increases the probability that the US Stock Market cycle is indeed turning down, and that NYSE Margin Debt will likewise fall from here. (Which is all usually bullish for Treasury Bonds)"
[12]
PCM notes that capital flows - namely global FX reserve growth vs global economic growth - have decoupled. They say that "the contraction in Global FX Reserves is more indicative of a ‘regime change’ in global capital flows, which increase the near-term risks of growing instability in world markets & economies."
[13]
Next, there is spec positioning in commodities. A simple correlation shows that specs are still positioned far too bullishly, which also explains the stratospheric forward energy P/E mulitples.
[14]
Then there is the observation of capital flows becoming more concentrated: "When conditions improve, capital tends to ‘disperse’ more within the economy and the capital markets (rising grey and green lines). However, when times get more challenging or participants are starting to get worried, capital will tend not to disperse, but concentrate into a few key areas (falling grey and green lines)."
[15]
PCM's Key Takeaways:
- We do not yet believe we have seen a top in Bonds, and submit further an excerpt from Sidney Homer that captures the sentiments of the previous multi-decade top in Bonds (hat tip: Lewis M. Johnson, whose work we would recommend to anyone’s reading list).
[16] - Such sentiment extremes are more consistent with market tops, such psychology being noticeably absent at present.
- The key risk is that the Bond markets collectively start to punish Government Policies, however, we believe there is still some way to go before such issues begin to gain traction. In fact, in order for Governments to take the more extreme policy actions required to cause Bond markets to revolt, it is highly likely that we would need to see a significant move higher in bond prices (amidst an environment of deflationary shock(s)) before policy-makers would have the tacit approval to escalate their policy experiments beyond the thresholds necessary to upset Bond markets and overwhelm the generally deflationary/low-or-no-growth conditions.
- Due to regime change dynamics that are starting to force an unwind of the last 7-15 years worth of conditions, and some of the issues touched upon in this presentation, we believe that investors around the world are likely to experience an increasing amount of ‘disorientation’ in the seasons to come. Such will require, almost demand, a slightly more ‘active’ approach to portfolio management as the changes in capital flows are likely to be quite paradoxical (& sustained) at times, and we would anticipate some larger swings in Velocity and increasing volatilities as well. In fact, it is primarily with regards to global velocity measures that we would submit will be one of the key metrics to monitor in order to confirm (or pre-empt) any possible turn down in the Treasury Bond markets.
Full presentation below
