The best thing to ever come out of RBS is back in its original format, now that Bob Janjuah has decided to begin releasing Bob's World again, if not with the unique trademarked grammatical style. That alone must be worth 95% of the intangible, and thus all, assets on RBS' balance sheet. To those who read just the first few paragraphs and are left scratching their heads if Bob was lobotomized in recent weeks and now sees nothing but upside, so contrary to his usual cheery disposition, we suggest reading on - that is merely his outlook for the short-term. The long one: "my view beyond July/August is bearish and very much risk-off. In late Q3/Q4 2011 I expect to see the beginnings of a meaningful sell-off in global risk which should take the S&P below 1220 and on its way possibly to the low 1000s. In this risk-off move I would expect – initially at least – USD to rally sharply, with the DXY index closer to 80 than 75, and major DM government yield curves to bull flatten, with 10-year UST yields falling to around 2.5%. Credit spreads should widen, but I expect non-financial corporate credit to outperform in relative terms. Having said that, in this major risk-off phase I still expect the iTraxx Crossover index to rise well above 500. And commodity weakness should be a major part of this late-2011 serious risk-off phase." Ah yes. Good old Bob.
Following client feedback, I am pleased to announce (in my new role as Head of Tactical Asset Allocation within Nomura's Global Fixed Income business) the re-launch of Bob's World.
1 – My last note was written in mid-April (In Bob's World USDs are not welcome), and in mid-May Kevin and I presented our latest thoughts in a conference call. The first six months of this year have proceeded largely as we expected both in terms of markets and in terms of the key issues/drivers (eurozone restructuring, EM growth vs inflation concerns, and (in particular in DM) concerns about fast diminishing policy options, policy ineffectiveness, and rapidly eroding policy credibility). Bonds performed well vs total equity returns for H1 2011 – as we expected after the run-up to the February highs – and using the S&P as a proxy, my narrow 1250/1350 and wide 1220/1370 S&P ranges have held. This year?s surprises – the Arab Spring and the Japan tragedy – have not, from a macro or markets perspective, radically affected matters. Rather they have added to the already existing underlying themes.
2 – In H2 I expect the Japan tragedy to have a silver lining, in particular in Q3. But overall the key themes which I see driving global markets in H2 will continue to be eurozone restructuring, EM and DM growth concerns, and fast diminishing and increasingly ineffective policy tools in DM in particular.
3 – In terms of markets for H2, I see two major phases, as follows:
A - Multi-day/Multi-Week: As the S&P held well at 1250 in the risk-off phase during Q2, I have been looking for a bounce and a multi-week risk-on phase. That bounce began in mid-late June. Over the next few days, as the bounce so far has been parabolic and led to over-bought conditions, I fully expect a mini-reversal with the S&P likely to drop 20 to 40 points. But over the course of July, with perhaps some leakage into August, I am bullish and risk-on. I fully expect to see the S&P at 1350 and probably also 1370. As a whole over July and maybe into August I am looking for 10-year UST yields to move to or towards 3.4%, leading to bear steepening of core DM government curves, and a fall in the USD DXY index to 73.5. Over the next few days, however, I expect a minicorrective risk-off phase which, as well as taking the S&P to 1320/1300, should also see core DM government curves bull flatten, 10-year UST yields back towards 3.10/3% (currently close to 3.2%), and the USD DXY index back up at 75 (currently low 74s).
B - This bullish risk-on call, in which commodities and credit spreads should also do well, will require a number of different “fundamentals” to validate the move. Kicking the Greece can down the road has been and should continue to be a support. The expected recovery in Japan and its expected positive impact on global PMIs has been and should remain another support. Some form of US debt ceiling “solution” could be another support. And most importantly, I think that the Q2 2011 sell-off may in large part have been driven by the front-running of the end of QE2 (much as late August into early November 2010 saw a real risk-on phase – the front-running of the implementation of QE2). In turn, much like in November 2011 when there was a multi-week risk-off phase once QE2 was actually implemented, in July I expect the equal but (of course) opposite – a risk-on phase now that QE2 has actually “ended”.
C – I certainly see the possibility of a surprise to my view of a risk-on phase over July/August. To the downside, I stick with 1250 and 1220 S&P as bear alert levels. And to the upside, which currently I see as the primary risk, the risk-on phase could extend deep into Q3 2011 with 1440 S&P as an extreme bull target. If the S&P progresses smoothly to 1350 and 1370 over the next few weeks, then I will reconsider the likelihood of a real break-out to 1440, which would also have significant implications for commodities (much higher), for USD (new lows), and for bond yields (could 10-year USTs reach 4%?) and curve shapes.
D – Multi-Week/Multi-Month: As paragraph 3A describes my base case in the very short term, then my view beyond July/August (and notwithstanding the points made in paragraph 3C above) is bearish and very much risk-off. In late Q3/Q4 2011 I expect to see the beginnings of a meaningful sell-off in global risk which should take the S&P below 1220 and on its way possibly to the low 1000s. In this risk-off move I would expect – initially at least – USD to rally sharply, with the DXY index closer to 80 than 75, and major DM government yield curves to bull flatten, with 10-year UST yields falling to around 2.5%. Credit spreads should widen, but I expect non-financial corporate credit to outperform in relative terms. Having said that, in this major risk-off phase I still expect the iTraxx Crossover index to rise well above 500. And commodity weakness should be a major part of this late-2011 serious risk-off phase.
E – As I have said all year, by late 2011 I think we will all be facing the reality of a Greece, Portugal and Ireland debt restructuring. We will likely also be faced with global growth weakness driven by fundamental demand gaps (as a result of the weak US/Western consumer and the slowing capex cycles in EM, especially in the BICs). In this context I worry that market expectations are moving and may move much too far ahead of the likely reality with respect to the post-tragedy Japan bounce and in particular its likely impact on global PMIs. And in late 2011, precisely when markets are looking for policymakers to sustain their unsustainable policies – or “ponzi” schemes as I think they should be called – I think markets are going to have to price in medium-term DM trend growth rates of 1-1.5% (with the UK and eurozone at the lower end, and the US at the upper end) and – especially in DM – fast diminishing policy options, policy ineffectiveness and rapidly eroding policy credibility. I suspect that, by end 2011/early 2012, policymakers in the UK may be considering QE2, in the eurozone peripheral debt restructuring will be the only credible policy option, and the US will be considering QE3. My views on QE3 remain unchanged – it can only happen if things get bad enough. In my view QE3 will utterly fail the US if it is merely a redux of QE2 as this is the pathway towards greatly increasing the risks of the USD and USTs eventually being priced as risk assets, rather than the global risk free benchmarks they currently are. QE3 must see the Fed supporting directly the real economy and real assets. So far QE2 is not perceived to have helped either real assets or the real economy, and in an election year the real economy and real assets – rather than pumped-up paper assets held largely by the elite and pumped-up commodity prices which benefit largely foreign suppliers and producers – will be all that matters.
4 – At this juncture I must stress that my tactical asset-allocation views may not necessarily fit in with Nomura?s views on various themes, forecasts and markets. As a house we are bullish Japan, we are not worried about a serious EM slowdown, driven by China, and we do not hold 2011 eurozone debt restructuring as a core view. Also as a house, we are more bullish on UK and US, as well as eurozone, growth. For more details on Nomura?s house view, please refer to Nomura?s Global Economics research. Also please refer to the work on QE3 which George Goncalves has contributed to as well as Laurent Bilke?s contributions on the eurozone.