JPM's head quant, Marko Kolanovic, who turned somehwat gloomy in the past few months, has seen some hits and misses in his recent forecasts. On one hand he did accurately predict the surge in gold one month ago, as well as the rebound in oil and Emerging Markets; however on the other he suggested that being long VIX and cash would be a good place to wait out the upcoming market volatility.
Most recently, when looking at the market's fundamentals which as we pointed out in late February are massively stretched, he also noted that "EPS recoveries that follow 2 consecutive EPS contractions (~20% of times) were typically triggered by some form of stimulus (fiscal, monetary or exogenous). We expect market volatility to stay elevated and investors to remain focused on macro developments such as the Fed’s rates path, developments in China, and releases of US Macro data. Elevated volatility and EPS downside revisions will provide a headwind for the S&P 500 to move significantly higher (via multiple expansion)."
Perhaps Kolanovic failed to anticipate the "animal spirits" response to first a stimulative PBOC, then a dovish BOJ, followed by an even more dovish ECB and topping it off, yesterday's dovish FOMC, which was clearly sufficient to boost both the Dow Jones and the S&P500 into the green for the year. He is correct, however, that in the absence of a major stimulus, EPS will likely remain subdued: after all the only "stimulus" from the ECB was a greenlighting for European companies to buyback their stock with ECB-backstopped debt issuance, while the Fed merely slowed down the pace of its rate hikes, confirming that the global economy is quite weaker than it had originally expected.
This is how Kolanovic explains this new period of central bank convergence:
Despite the negative rates and recently expanded stimulus by both the ECB and BOJ, EUR and JPY are trading stronger against USD. The USD trend was reinforced with a dovish turn from the Fed yesterday (which we advocated in our previous reports). We think these are early signs of the Central Bank Convergence trend. We think this convergence was one of the catalysts that led to the dramatic outperformance of Value over Momentum assets in the first quarter of this year. Figure below (left) shows returns of Gold (left axis) and USD (right axis, inverted) on the Fed announcement dates since 2009. During the period of Quantitative Easing 2009- 2013, gold kept surprising to the upside and USD to the downside on most of the announcements. The trend was sharply reversed after the end of QE3 and the beginning of the Fed’s removal of stimulus in 2013-2015. We have noticed that over the past several months, USD is underperforming and Gold is outperforming on both Fed and ECB meetings. Figure below shows USD and Gold moves on ECB dates since the start of Fed’s taper speculation in 2013, also showing signs of central bank convergence over the past 6 months. In our view, central Banks are on a convergence path which would stop the USD rally and be supportive of value assets – to the benefit of both the US and global economy.
Given the recent moves, USD momentum turned negative on 3M and 12M time horizons, and is vulnerable to turning negative across the term structure. Even if the USD stays at these levels, momentum would turn negative across all maturities over the next few days. This could put further pressure on USD as CTAs reverse their favorite long position into a short. Lower USD would further boost commodities, EM assets, Gold and Value stocks. Gold momentum is now positive across the term structure (CTAs long) and will likely stay so. Figure below (right) shows our ‘CTA signals’ for main asset classes.
So what does Kolanovic think happens to the market now? Here is his latest take:
As we wrote in our last report, a significant part of the S&P 500 rally the past month was due to systematic investors covering their short positions. Over the past few days, dealers’ option imbalance was tilted towards calls (long gamma) which forced the market to trade in a tight range. This has reduced realized volatility and attracted some inflows from volatility based allocators such as Volatility Targeting and Risk Parity funds. The exposure of systematic investors to Equities is not very high and further inflows could materialize if the S&P 500 were to get into a 2050-2100 range, where S&P 500 momentum would turn solidly positive across term structure. The downside/selling triggers are placed a bit lower (which is marginally positive for equities) as momentum turns negative around ~1950. However, in the next week, we could see some downward pressure as the impact of option hedging is reversed. Historically, we have found that the market develops positive momentum during the 3rd week of the month (when there is a call imbalance), and this often reverses during the 4th week of the month.
Finally, an interesting tangent by Kolanovic on none other than Donald Trump, regarding whom he says "we think the chance of Trump winning the presidential elections is significantly higher than what is suggested by various surveys." Would that be "we", as in including Jamie Dimon, or the editorial "we", because if even the big banks are onboard, then it's about to get interesting.