The latest from Nomura's Bob "the bear" Janjuah
Power of the Fed's words waning?
I wanted to update my two earlier notes from this year, published on 7 January (link) and 4 March (link). The two specific drivers for this update are outlined below and are linked to each other and to the two notes referenced above:
1 – The rally off of the February lows in risk assets has been marginally stronger than I had earlier anticipated, but in particular has lasted a fortnight longer than I had expected. As per my March note my stop loss for the rally off of the February lows was set at (based on the cash S&P500 index) consecutive weekly closes above 2040. And I expected the next bear leg to begin in early or mid-March. So far my stop loss has NOT been triggered – we have come close, and if we close above 2040 this Friday then my stop loss will be activated, but 2040 has proven to be a great pivot point for the last three weeks. I also note with much interest that outside of the major large cap US indices things already look much more bearish, most notably in Japan and Europe, where in both cases risk markets have been rolling over into bearish price action since early March. Furthermore, core duration markets have traded very well, not just in Europe and Japan, but also in the US. Nonetheless, as my stop loss may soon get triggered I wanted to present this update.
2 – I set out in January that (globally) risk assets (stocks, credit, commodities and EM) would struggle through H1 2016 and that the only relief would come from the Fed admitting failure and flipping to dove mode again, thus weakening the USD and providing relief to crude, commodity, EM, credit and equity markets. In March I re-emphasised my view that the Fed ‘put’ (i.e., the point at which the Fed admits failure and flips from hawk to dove) would not be seen until mid-2016 and would require the cash S&P500 index to drop into the 1500s. Clearly, I had given the Fed too much credit – it flipped after a drop to 1810 and shifted in March, all much earlier than I had expected.
With all this in mind, how am I left?
1 – Clearly, my confidence on my negative views for global growth, on my belief in deflation over inflation and on the deeply negative outlook for earnings are now set even more in stone. The Fed has told me as much. In fact, I suspect that the Fed in private is far more concerned about these factors then it is currently willing to admit.
2 – The Fed’s change in March was all about weakening the USD, which in turn is designed to help the US economy fight off imported deflation, instead of which the Fed hopes to import inflation into its economy (all to try and hit the 5% nominal GDP growth target which I discussed in my March note) and with it the hope that it helps US exporters regain competitiveness. USD weakness also helps crude and commodity exporters, and it helps the EM world, which has suffered from commodity price weakness and tight USD financial conditions at a time when the EM world is drowning in USD debt. China is a huge beneficiary as the Fed’s flip and USD weakness allow China to continue devaluing vs the world ex-the US without having to do anything itself, and it helps (at the margin) the heavily USD-indebted Chinese economy. The big losers are of course Japan and Europe, and this is compounded by the fact that both the ECB and the BOJ are, in my view, already at the limits of what they can do credibly. Just look at price action on the EUR, on European stocks, on core duration in Europe, on the JPY, on the Nikkei and/or on JGBs. The charts speak for themselves and should concern policymakers at both these institutions.
3 – I am also even more convinced now that we are about 10 months through a multi-year bear market that likely won’t bottom until late 2017 or early 2018. This will be a stair-step decline with all the strength to the downside punctuated by occasional (very) violent bear market counter-trend rallies driven by short covering, hope and residual (albeit rapidly decaying) belief in policymakers. I still feel confident that we will see 1500s on the cash S&P500 index in late Q2 or Q3, and some of the things I look at suggest a final bear market bottom for the cash S&P500 index around the same levels as the 2011 lows of sub-1100. However, this is a longer-term idea that will be subject to refinement. The focus must be on the next few days, weeks and months.
4 – In this light the first hurdle or trigger is this Friday’s equity market close in the US. If the cash S&P500 index closes above 2040 then I will be stopped out. In such an outcome the risk then is that we head towards the highs of November 2015 (2116) or even May 2015 (2135). Of course if we fail to close above 2040 this Friday then the view for Q2 2016 outlined in my March note would continue to apply, targeting a fresh leg lower into the 1700s for the cash S&P500 index over the next few weeks, and with a larger move into the 1500s by late Q2 or Q3. Within this I would expect at least one violent countertrend bear market rally, perhaps over late Q2 or early Q3, taking the S&P from the 1700s (if I am right!) up into the 1900s before the leg lower into the 1500s over late Q2 or most likely Q3. I am comfortable that such a period of positive counter-trend price action for risk assets will NOT be based on material and sustained improvements in global growth or earnings, rather the drivers would still be hope and a strong view that the Fed is actually going to ease (i.e., action or promises of action in the dovish direction rather than just words or promises not to hike).
The critical longer-term question to my mind is whether the Fed is going to re-introduce QE and/or cut rates ultimately into negative territory. This takes us into the realm of when and what would the necessary pre-conditions need to be. This in turn takes us into the realm of credibility. My view – and it is only my view, as nobody can know the answers to these three questions for sure, is still that the Fed does not actually do anything more than jaw-bone until or unless the S&P500 cash index is into the 1500s and the outlook for growth, employment and inflation get significantly worse – perhaps with the unemployment rate inching higher not lower. Timing wise late Q2 or Q3 is still my target, though the closer we get to the US presidential election the more the Fed will be hampered. In terms of credibility, while I think the ECB and the BOJ are scrapping the barrel, the Fed still has the ability to influence things, at least for now.
What this also all means is that while I may suffer a stop out soon, and stop losses exist to be respected, I also do not think that this current rally leg has much left in it – the power of Fed speak without Fed action is already waning I think. Consecutive weekly closes above 2116 (possibly) and/or 2135 (definitely) would force me to reconsider my views for the rest of Q2 and Q3. Until or unless these levels are crossed I would urge investors to be extremely cautious about getting too long risk and getting overly complacent.
The underlying global growth and earnings outlooks are poor and deflation is still running rampant, albeit right now perhaps more so (at least in terms of perception) in Europe and Japan than in the USD-bloc (which includes almost all EM economies, as well as the usual economies such as Canada and Australia). As everyone wants a weaker currency, I do not expect the period of USD weakness we have seen since early March, and which has been the real catalyst for the latest ramp-up in risk assets and hope, to last unabated for much longer without much more explicit easing/explicit promises of easing by the Fed which, as I have said above, is unlikely until things get much worse. More likely are fresh attempts by the ECB and/or the BOJ to ease to drive down the EUR and JPY before the Fed can actually do anything explicit. In my view, this, of course, will put Chinese devals back on the table. The global FX war continues, which on any meaningful timeframe is ultimately a destructive outcome for the global economy. It seems sad that central bankers are so focused on transitory and largely illusory wins, which have served the global economy so badly over the last decade.