Bob Janjuah may nt have rvrted to his RBS wrtng style of yore, yet, but the New Nrml appears to also fnly b getting to 1 of our fvrte strategists, who has finally gone bold, ALL CAPS.
From Bob's World: Are We There Yet?
I last wrote in November (Risk not on?) and since then markets have broadly continued to track the medium-term bigger picture outlook set out in that note, as well as the shorter-term tactical "S&P500 1450/1475 rule? that I also discussed in that piece and in my earlier September note (Stop Loss Update). I wanted to publish now to provide some extra clarity:
1 – The medium-term and the ‘1450/1475 rule’: I wanted to recap the views set out in the above notes. Over the medium term – the first half or so of 2013 – I expected risk assets to rally with the S&P500 trading in the 1500s. Drivers were largely centred on more kicking of the can by policymakers. In terms of the "1450/1475 rule? for the S&P500, in place since September, the call has been and remains that on any weekly close above 1475, the outlook for risk assets is bullish and remains bullish until and unless we see a weekly close below 1450 for the S&P500, at which point the outlook flips to bearish. And the 1450/1475 zone for the S&P remains the neutral/zero position/no-go zone.
2 – Fundamentals vs. Policy – also known as "the gap between the real economy and financial markets high on the synthetic intoxicants coming out of central bank laboratories?: I have written before about the grotesque – in my view – and persistent misallocation of capital (in financial markets) being caused by the mispricing of capital/money by central banks; by their ongoing "promises? to misbehave – seemingly forever – such that anyone with good common sense will eventually be battered and beaten into submission and be forced into the misallocation game; and by the – again, in my view – irresponsible behaviour of fiscal policymakers too. Collectively, we have a huge global game of kicking the can down the road driven by excessive and wasteful government largesse, funded by explosive growth in central bank balance sheets. Future generations will and indeed already are beginning to pay (chronic youth unemployment in the Western world is the current channel) for what I see as deeply depressing policy settings and failed policymaker thinking, which persists with the idea that some form of debt-fuelled asset price elevation will lead to real wealth creation, which in turn will fix all our ills. The "movie? has been run before – too many times – and failed. Mispricing capital and forcing indebtedness into the system is an artificial booster of asset prices – in other words, such policy settings create asset price bubbles that always burst badly. NASDAQ 5000 was one recent example. And of course the huge bubbles that burst in 2007/2008 are another. Real wealth can only be created by innovation and hard work in the private sector, with policymakers, the financial sector and financial markets there to aid and encourage/incentivise. Real wealth is not created by the printing press and by excessive government spending. We simply cannot turn wine into water – after all, if it were that easy, why have we not done this before (with any lasting success, as opposed to abject failure, for which there is plenty of evidence)! Sure, central bankers through QE can create a chemical/synthetic concoction that may well get us even more intoxicated than real wine, but like most chemical processes that are focused on by-passing the rules and focused on immediate quick fixes, the "wine? they are synthetically creating will I fear ultimately lead to either a large market hangover (at best) or – at worst – to the "market equivalent? of serious liver poisoning or something even worse. The scale of the fallout will I feel be determined largely by how far markets and policymakers are willing and/or able to stretch the elastic band between real world reality and liquidity fed asset markets. Past experience shows us that this band can be stretched a long way, and we know that central bankers have a bad track record at both spotting and managing asset bubbles.
3 – Positioning and Sentiment: The most significant new developments have been in the realm of positioning and herding. Market sentiment had already been turned primarily by Draghi in the early summer of 2012, and the Fed's QEI leant heavily into this – as has the subsequent actions and/or words of other notable policymakers. But – and with the benefit of some hindsight – the missing link in calling the big top in the secular equity bull run out of the 2008/09 lows has been positioning. Market participants had – on a broad-based basis – simply been too cautious in terms of positioning structurally in risky assets. Without extreme positioning (long or short) markets tend to only see medium-sized corrections at best/worst, rather than big collapses. A key part of the positioning extreme is LEVERED positioning. Well, based on everything I have seen and heard from the flows and from talking to clients across geographies, across asset classes and across investor types, positioning is now getting structurally long risk. Folks are fearful of missing a raging bull market (no matter how poor the foundations of such a bull run maybe in their eyes), they are fearful that everyone else will enjoy a risk-on bonanza while they suffer from being too cautious, and they are looking to buy all and any dips. Herding is a natural animal phenomena and the markets are now beginning to herd in the "it?s all gonna be OK, get short bonds and get structurally long risk? camp. At peaks we see levered positioning in risk, and this is now clearly on the increase too. The number of times I have heard from clients that "with central banks in full QE mode, financial market risk asset prices can ONLY rally? can now almost be described as a cacophony. The key word here is "almost?. I don't think investors are yet "fully? positioned. We are "not there yet?. There is not yet sufficient leverage in risk-on positioning in my view. I think we need at least another round or two of "buying the dip? before we can consider positioning to be at extreme enough levels to set up the conditions necessary for a major sell-off (25% to 50%) as opposed to a minor correction (5% to 10%).
4 – Market Outlook: As can be inferred from the above, in the medium term (2 quarters +/- 1 quarter), and as per the route map in my previous notes, I think risk can rally further. I continue to believe that the S&P500 can trade up towards the 1575/1550 area, where we have, so far, a grand double top. I would not be surprised to see the S&P trade marginally through the 2007 all-time nominal high (the real high was of course seen over a decade ago – so much for equities as a long-term vehicle for wealth creation!). A weekly close at a new all-time high would I think lead to the final parabolic spike up which creates the kind of positioning extreme and leverage extreme needed to create the conditions for a 25% to 50% collapse in equities over the rest of 2013 and 2014, driven by real economy reality hitting home, and by policymaker failure/loss of faith in "their system?. I always like to remind clients that, in the run up to the 2000 and 2007 highs, before the significant collapses that followed in the subsequent 18/24 months, markets seemed infatuated in Greenspan and his famous "Put? the same way today?s teenagers seem infatuated with Justin Bieber, investor complacency was off the charts, volatility was at record lows, belief in "the system? was sky high, and positioning was at extremes. The flashing common sense warning signs were being ignored, if not mocked. Time – the next 18/24 months – will we think provide the answer as to whether we are witnessing a repeat disaster in the making. IF I AM WRONG AND WE TRULY HAVE FOUND ECONOMIC AND MARKET NIRVANA SIMPLY THROUGH THE CENTRAL BANK PRINTING PRESS AND ENORMOUS INDEBTEDNESS, THEN I WILL HAVE NO HESITATION IN ENJOYING THE FUTURE, THINKING ABOUT THE FUNNY MONEY MIRACLE, NEVER NEEDING TO WORRY ABOUT ECONOMIES OR GROWTH EVER AGAIN (all hints of sarcasm entirely intentional). Tactically, over the next quarter or two, I expect to see one or two (at least) 5% to 10% dips or corrections ((there are after all many banana skins ahead in terms of politics, policy, and economic fundamentals), but which I think will be short lived and heavily bought into largely by latecomers (retail?) to the party, encouraged by more central bank promises. One such correction is due now and should take the S&P500 down by 5% or so (from 1515 to 1440ish) over the first few weeks of February. Over the end of February and the first half of March (at least) we should see risk assets rally back into the 1500s (S&P500) – and most likely above 1515. Two asset classes that may lag any such a rebound rally are credit (IG and HY) and EM. Credit markets in particular are I think great early indicators of a secular change in the direction of (equity) markets and it may well be the case that we have already seen, or will over the very near future (the next quarter) see the grand cycle tights for credit spreads.
Enjoy the dips. And focus on being very tactical and liquid, whichever way you feel markets are going to trend. Now is not the time to be getting overly levered, overly "structured?, or overly illiquid with respect to portfolio positioning. And good luck for 2013 and beyond.