The latest Bob's World From Nomura's Bob Janjuah
Back on Track
My last note, back in the beginning of April, concluded that:
"…in Q2 we should expect a nice 10% equity sell-off, with the S&P500 falling from 1420 (+/-20) to 1280 (+/-20). Credit should continue the sell-off of the last few weeks (iTraxx Crossover up at 750/800), and rates should rally with 10-year UST yields back below 2%, perhaps even down at 1.75%..."
After a poor January and February, it was nice to get firmly back on track re the global market call – using the S&P500 index as the risk-on/risk-off proxy, a "top" was – as forecast – in place at the beginning of Q2, at 1422 (intra-day high), and then followed an almost perfect 10% correction lower, with the S&P troughing at 1267 (intra-day low) in early June. The iTraxx Crossover index did indeed widen out from around 550bp in early Q2 to just over 750bp in early June. And we saw 10yr UST yields rally hard from around 2.25% in early Q2, all the way down through the rally target (1.75%) and ultimately we saw yields trough below 1.5% in early June.
Going back to the early April note I also concluded that, after the forecast correction (which as highlighted above has played out in line with our projections) we would get:
"…later into Q2 I think the shrill promises of more fixes of "M"…will get loud, and many investors remain underweight risk, having missed out on Q1. As such, the expected correction should not exceed 10%. Over late Q2 and Q3, we could – likely should – see another leg higher in risk, driven by TWIST. This shot of „M? may have a very short half-life in terms of boosting markets…" but "…I continue to believe that…equity prices may surprise on the upside in Q3…"
My current view remains pretty much unchanged. I am fully aware of the current phase of eurozone concern (Spanish bank recap, Greek elections), but neither I nor my colleague Dr. Kevin Gaynor believes that any form of eurozone exit/break-up is a likely reality for this year. Ultimately we both believe that, in the short run, Germany will „blink?. We also continue to believe that policymakers in the eurozone (fiscal and monetary), in the US (the Fed) and in China (fiscal and monetary) will attempt once again to pump things up.
The effectiveness of „more policy? is clearly waning and seems to have a rapidly decaying half-life when it comes to successfully pumping up risk asset valuations. Furthermore, policymakers are indeed fast running out of effective tools and ammunition, but at this point in time we think it is too premature to assume that policymakers have either zero options or that they will have zero impact. To be clear, Kevin and I expect some form of Fed TWIST+, but no meaningful outright QE – that will be reserved for late this year if – as I fear – the US has its own a fully-fledged fiscal crisis.
Even with "just TWIST+" rather than QE, together with our expectations that China will make some (albeit very modest and targeted) attempts to stimulate, and our belief that some (albeit not genuinely game-changing) real progress and hard capital (rather than more debt!) will be seen in the eurozone, we should – factoring in the currently very bearish sentiment (if not positioning) in the market – see some form of risk-on relief over the back end of Q2 and early Q3.
As per my April note and the extract above, my expectation remains that this risk-on phase should see the S&P rally over late Q2 and through July, possibly all the way back up to the 1400s, perhaps even setting new cycle highs (around 1450) by late July or early August. In this risk-on phase core bonds should sell-off – I have a 2.35%/2.45% 10yr UST yield target, and I expect the iTraxx Crossover index to rally back below 600bp, maybe even below 550bp by late July or early August.
My stop loss over the next 4-6 weeks while I expect this risk-on phase to play out is simple: a weekly S&P close below 1267 would for me be very bearish and likely change things. But as mentioned, instead I expect to see markets struggle with headlines and volatility, but ultimately climb the wall of worry up towards 1400, perhaps 1450 S&P.
And then? Well, again things are largely unchanged from my April note. Much beyond late July or early August, and assuming we get to 1400/1450 S&P, I then would look to position for an extremely bearish risk-off phase over late August through to November or December. The drivers of this extremely bearish expected phase are not new: overly bullish positioning and sentiment; weak global growth, not just in the eurozone but also in the US and the BRICs; the next leg of crisis in the ongoing eurozone debacle in my view; and of course the looming US fiscal crisis, which in my view is not even "slightly" priced into markets, but where I feel the probability of a crisis is close to 75%. Hopefully by year-end US sell-siders will realise that blaming the eurozone crisis for everything that is going wrong in the US has been a serious error, which has resulted in them being blind-sided to the other real „gorilla?s in the room? – namely the US debt/fiscal weakness, and the hard landings now beginning in the BRICs.
My forecast for this extremely bearish risk-off phase over late Q3 and Q4 is that the S&P500 trades below the low of last year, perhaps as low as 1000 +/- 20. The iTraxx Crossover index should over that period widen from around 550/600bp (my end July/early August risk-on target) out all the way to certainly 800bp, and more likely closer to 1000bp. And we should see core bond yields rally hard – I expect 10yr UST yields to rally from my 2.35%/2.45% end July or early August target, all the way down to 1.5%, maybe even lower.