In Marko Kolanovic' last note profiled here in mid-March, the JPM quant flagged that while a market pullback is likely - he was right: the biggest market drop of the year took place just days after - that investors "should be buying the dips (BTD) due to favorable political and monetary outlook (Trump and Fed Puts)." He also forecasted that volatility would rise due to a shift in option positioning, which was responsible for suppression of realized volatility, increase in correlations, and pipeline of catalysts. And, indeed, he was right about that as well, as the market has experienced weakness since early March, most of the pullbacks were bought by investors, and volatility increased (see Figure 1).
Fast forward to today when in a just released note, Kolanovic says that "clients are now asking us if it is still our view that every dip needs to be bought."
"We think that would not be prudent over the next two to three weeks given the recent geopolitical developments and related tail risks. These geopolitical risks are primarily related to an escalation of tensions with Russia and North Korea, and the upcoming French elections. Before the US elections, Trump campaigned on a platform focused on domestic issues (jobs, taxes, manufacturing). Following the failure of the ACA repeal and immigration bills, focus has unexpectedly shifted to foreign policy. Strikes on Syria, shortly followed by the dispatching of Carrier Strike Group 1 to North Korea, took many by surprise. These geopolitical developments create tail risks for equities as well as for the Trump administration’s domestic agenda."
Kolanovic lays out all the ongoing risk narratives,which are only getting bigger by the day:
- Russia / Syria: New “red lines” set by the Trump administration raise the risk of confrontation with Russia. Russia has set its own set of “red lines” (e.g., president Putin has publicly stated that the Idlib attack was a False Flag operation). Maintaining credibility on these “red lines” could lead to a broader conflict. This may in turn erode support from Trump’s pre-election voters and could bolster his pre-election critics (who portrayed him as, for example, unfit to be trusted with nuclear codes). If Trump doesn’t continue on his current course, he may lose credibility on both sides of aisle (inviting further questions on links to Russia, inconsistent foreign policy agenda, etc.). According to various social media analytics, there are already indications his pre-election support base is eroding.
- North Korea: In addition to escalation with Russia, there is a simultaneous escalation of the crisis with North Korea. As Strike Carrier Group 1 is on its way to the conflict zone, China is moving troops closer to the border. Similar to the US and Russia, China likely has a set of “Bottom lines.” In addition to the risk of outright conflict, possible outcomes include an increase of China’s influence in the region, risk of loss of credibility for the current US administration, and others.
- France election: The dynamics of the French election have taken another turn and are increasingly reminiscent of Brexit and the US election. With many possible outcomes, including a second round involving far left and far right candidates, many clients are increasingly concerned with the April 23 event. We also note that three of the four most likely candidates disagree with current US foreign policy (e.g., in relation to Russia), which can further complicate the risks mentioned above.
And his summary assessment of why traders should lay off the BTD for the next 2-3 weeks.
In our previous recommendation to “buy the dips” we relied on Trump’s ability to stoke animal spirits and formally or informally introduce new pro-growth policies. Over the next two weeks, congress in in recess (shortly followed by expiry of the current spending authorization), and informal pro-growth proposals may lack credibility during the ongoing geopolitical crises. While one cannot predict with certainty any of the above outcomes, it appears to us that buying the dips over the next two to three weeks would be imprudent.
Now if only someone could translate this note into binary code to reach its intended audience.