Kolanovic: "The Month Of December Proved Us Wrong"

After no less than six consecutive bullish reports, urging JPMorgan clients to buy the dip, first on October 12, following the systematic puke, then one week later on Oct. 19, then again on Oct. 30  when stocks hit another recent lows, then once more on November 7  after the midterm elections, then once again on December 3, and most recently on December 7 when Kolanovic blamed "specialized websites that mass produce a mix of real and fake news [and] often these outlets will present somewhat credible but distorted coverage of sell-side financial research, mixed with geopolitical news, while tolerating hate speech in their website commentary section" for screwing up his bullish bias, he decided to take a well-deserved one month cheerleading break... during which the market imploded.

And with so many expecting the quant "Gandalf" to pray explain just what happened that Kolanovic predicted almost none of it, on Thursday afternoon Kolanovic obliged and blamed it on disappearing investor confidence, to wit: "Over the past month, the confidence of equity investors virtually collapsed."

That said, the Croat graciously admitted that "the month of December proved us wrong in the view that the market would rise into year-end and in 2018 overall" and elaborates that his "call for a year-end recovery was based on near-record low equity positioning (HFs and systematic investors), near five-year low in valuations (forward P/E and PEG), positive seasonality, and two positive catalysts (G20 and the Fed’s dovish pivot)."

And yet, to anyone who traded on his recos and watched their funds also disappear, the quant adds that "all of this was too little, too late amid the liquidity collapse, retail investors fleeing the market, weakening fundamentals, and more uncertainty coming from Washington." 

Indeed it was, which is ironic because after all as a strategist, it was Marko's job to predict "the liquidity collapse, retail investors fleeing the market, weakening fundamentals, and more uncertainty coming from Washington" instead of ignoring it while desperately clutching at hopium straws.

But we digress: after all there is the "fake news" media to blame for any incorrect call.

Or maybe, just maybe, it was the realization that the fundamentals were never as strong as Kolanovic made them out. The quant finally admits as much, noting that "continued signs of economic slowdown reinforced investors’ fears that a recession is around the corner, which is not our house view."

Well, actually, it was Nikolaos Panagirtzoglou's view, something he highlighted in December and said that it may be time for a battle royale between the two JPM strategists to duke it out so we can find out who was right. Or we could just wait as the market would ended up giving the answer (it did).

So getting his near-term calls all wrong, what does Kolanovic do? Why focus on his prior, and far more respectable and accurate calls:

In 2017, we published a report about the potential onset of a liquidity crisis in 2018 that could evolve at the back of QT, rising rates and volatility, systematic selling, a collapse in market liquidity, and social and political tensions. We highlighted the scenario during the summer as well, but given the solid Q3 GDP, strong corporate earnings, and record consumer activity, we did not think a significant liquidity crisis scenario would play out on such short notice in Q4 2018. Q4 turmoil appeared amid selling from systematic and discretionary hedge funds, the largest fund outflows since 2008, and an unprecedented collapse in market liquidity.

What we fail to grasp is why, when Kolanovic correctly knew the big picture, did he so blindly push investors into a year-end carnage (actually, we have a few ideas but we'd rather keep them to ourselves lest we be accused of spreading fake news.)

At that point Kolanovic issued a mea culpa, sort of:

Despite being wrong on the overall market direction, we had several correct predictions in 2018: we forecasted volatility and tail risk to rise, accurately predicted local market bottoms on Feb 9, May 1, and October 30, argued for EM-DM convergence, and pointed to US administration policies and the Fed as the key risks.

Yes, indeed, Marko did make some correct calls. Unfortunately he also made some major blunders and we wonder which will be remembered by the investing professionals, even with the benefit of hindsight "explanations" such as the following as to why he was wrong:

Following the selling from systematic investors in mid October and hedge fund deleveraging in late October, positioning was lightened significantly. Indeed, during November, flows stabilized and the market managed to produce a small positive return. It seemed briefly that the G20 and Powell’s speech would be sufficient to prod the market into a December rally. Instead, already fragile sentiment was undermined by political uncertainty from the US administration, the December FOMC meeting, a slowdown in economic data, and a viciously negative news and social media cycle.

Phew, at least it wasn't the fake news' fault that the true shape of the fragile economy, both in the US and globally, finally emerged (or perhaps Apple was also just spreading fake news?) Anyway, the "viciously negative" social media cycle - and other developments - "brought a large amount of selling from mutual fund investors in an environment of poor liquidity."

Kolanovic then goes on to praise the gods of pension rebalancing - which he may have discussed ahead of time instead of after the fact, as some "fake news" websites did in "Brace For "Seismic" Volatility: Pensions To Buy Record $60BN In Stocks In Coming Days" -saying, correctly, that only the the fixed- weight portfolio rebalances (e.g., pension funds) that were buying a significant amount of stocks during the last week of the year "averted a complete disaster." And then, once again with the benefit of hindsight, he says that:

"Figure 2 shows model equity flows for fixed-weight portfolios (% of equity assets, left axis). In these charts, one can see that both retail outflows and pension inflows were among the largest in history (only 2008 and 1987 saw larger flows). The impact of these flows was exacerbated by the collapse in liquidity (dashed lines on right axis shows the equivalent % fund flow, when adjusted for prevailing market liquidity). We believe that these flowsand the volatility they unleased were significant drivers of the poor price action in December."

In short, everything that was predicted here... two weeks earlier.

So with all that, is Kolanovic still uber bullish or is he finally throwing in the towel? Well, its complicated, because while on one hand he notes that there has been a veritable puke by retail offset by buying by pensions, which he finds a bullish signal, as "both mutual fund and pension flows suggest positive market performance in the future", he no longer is as confident as he was in his past 6 notes, and writes that "that said, we do recognize that the risk of a negative feedback loop (e.g., wealth effect of declining stock market) has increased meaningfully since December."

So sell? Well, it's not clear, but we are confident that Marko will give us the right answer... right after the fact.