by Bob Janjuah, Nomura International
Tick tock, not yet bear o’clock
Hopefully by now you will all be done with reading the many "year ahead" type pieces so beloved of the sell-side. I will instead stick to my "running narrative" by updating my last note from early November 2013.
1 – The Q4 2013/Q1 2014 forecast was for risk-on, but also I felt we would see one or two bouts of higher volatility and mild selling at the back end of Q4 2013 that I felt would be good entry points for tactical risk-on positioning. I had an S&P target by end-Q1 2014 of 1850 (from 1750), and a VIX target of 10 (from just under 14). It has been very pleasing to capture 100 S&P upside points since this call, and to note that so far the peak in S&P has been (to the point) 1850. The VIX rally has also played out directionally but, so far, 12 has been the low point. It is also pleasing to note that we did see some mild weakness in December in the risk-on trade, creating the risk buying opportunities I was looking for, whereby VIX peaked at just over 16 in December before rallying to 12.
2 – Markets have moved in a broadly sideways fashion since my targets were hit. I think this reflects the fact that positioning and sentiment had gotten extremely bullish into year-end, too bullish I would say, and with less than stellar earnings and economic data emerging since Christmas we are (so far in January) having to work off these extreme overbought conditions. I suspect there may be a little more to go over the next two weeks or so, but unless we see a weekly S&P close below 1800 – which I doubt – I expect this slight weakness to pass. It should instead be considered a tactical buying opportunity.
3 – Based on my VIX call, whereby (as per my previous note) I expect to see the VIX index hit 10 before the onset of the next major risk-off downturn – and beyond the very short term (point "2" above) – I think there will need to be more risk-on over the second half of Q1 2014. By the time we get into April +/- a week or so, I expect the VIX index to have traded down to 10 and, during this expected risk-on phase, I would look at 1850 as an initial S&P target. Upon a weekly close above 1850, I would not be at all surprised to see a strong risk-on move over the second half of Q1 and into April, taking the S&P into the 1900s, perhaps as high as 1950. It is worth remembering that blow-off parabolic spikes into a meaningful top tend to surprise in their "strength".
4 - What will drive this "strength"? More of the same I suspect – any weakness in earnings will be ignored (virtually all of last year's equity market gains were NOT earnings or revenue growth driven, but were rather virtually all multiple expansion driven), any bad economic data will be ignored – the weather provides a great cover, and instead markets will I think see (one last?) reason to cheer the Fed and/or the BOJ and/or the ECB and/or the PBoC. In particular, the market will fully expect a more significant BOJ easing after the coming tax hike, and I have little doubt that Ms Yellen will – for now – be dovishness personified once she is officially in charge and starts speaking.
5 – Beyond this next few months, and with the caveat that the VIX index hitting 10 is a prerequisite, I stick with the view outlined in my November note – that over the rest of 2014 and into 2015 we could and should see a significant reversal of the bull-run since March 2009. Not necessarily in terms of systemic panic (à la 2008), but more in terms of the normalisation of the (real) cost and availability of capital, of (the true levels of) market volatility, of growth expectations, of valuations, and of incomes and earnings expectations, resulting in the "NPV-ing" of all these factors once markets accept that current (central bank) policies are neither credible, sustainable nor consistent with real economy success. The only real "success" of these current policies is to create significant investment distortions and misallocations of capital, at the expense of the broad real economy, leading to excessive speculation and financial engineering. If I am right about the final outcome over 2014 and into 2015, the non-systemic three-year bear market of early 2000 to early 2003 may well be a better "template". Of course the S&P lost virtually the same amount peak-to-trough in both bear markets, and in real (as opposed to nominal) terms actually lost more in the 2000/03 sell-off than in the 2007/09 crash.
6 – Just to recap the underlying worries I have, they remain: Global Growth – mediocre at best, in both EM (China, Brazil, Turkey, Indonesia and India – call it 50% of the world – are too big to ignore and stalling hard. They cannot survive the deflation that the eurozone and Japan especially are exporting to them considering their mixed combinations of heavy indebtedness, deficits, uncompetitive labour markets and in particular in the case of China, an FX regime that is hugely deflationary too) and DM (I fully expect the US to disappoint – again, just look at the PCE indicator that is flashing US DEFLATION, and the eurozone is flat at best for growth, has unsustainable debt dynamics and is also a major DEFLATION hot-spot). Furthermore, the disparity in wealth and incomes in the West, where the policies of the last five years have only really enriched the top 1% at the expense of the rest is, in my opinion, one of the most unpleasant and unsustainable developments in our societies; Global Demographics – extremely poor everywhere except perhaps India and sub-Saharan Africa – and China, Europe and Japan in particular are major concerns over and above the end of the US baby-boom era; Global Speculation – I live in central London and I can only say what I see; and Global Hope – at a very macro level policymakers were way behind the curve in the period 2004/05 into 2007/08, hence the bubble and subsequent crash, they got ahead of the curve late in 2008/early 2009, hence the recovery in markets, but now again look way behind the curve, persisting with a set of policies that have merely built up speculative excesses again and which are reliant on policymakers continually adding more fuel to the already blazing inferno.
7 – Without turning this into a year ahead-type note, I wanted to highlight what I think could be three big surprises for the year over and above (but of course linked) to my views above: Currency Wars – the big one, China! At what point does China and the RMB say "No Mas?"; Japan – what if the squeeze on real incomes and the squeeze on the SMEs is so strong that the BOJ does NOT deliver more new easing beyond March year-end? The JPY has been a one-way trade and is now the major funding currency of the global carry trade – any sign that the BOJ and Prime Minister Abe are blinking would be very difficult for the broader global markets; and lastly, the Fed – to taper or not to taper – what if the data become even more volatile and mixed? Does the Fed reverse taper? What about credibility? And what if the PCE reading drops below 1%? Going from over 2% to 1.1% is disinflation and "good" for all assets in a QE world, but a sustained move below 1% is not good for risk assets and growth expectations and would surely prove, once and for all, that QE is little more than money illusion. The new Chair of the Fed may end up with a major credibility gap, having been so wedded to this policy. And what would it mean for Abenomics (albeit in Japan there is at least an attempt to force some real economy reform).
Best of luck to all for the year ahead.
Regards
Bob
