When I last wrote I highlighted how uncomfortable I was with the bounce in risk assets after the capitulation in mid-October. This concern only got bigger as risk assets rallied over November simply because the data flow, the news flow, and in particular the price action below the surface in equities was flashing warning signs. Some will dismiss this, but the Hindenburg Omens that US stock markets were giving off in very early December were a clear warning.
Since early December the S&P has dropped over 100 points (5%) and the 10yr Note has rallied over 30bp. Other equity markets around the world have generally fared even worse, and some other core bond markets have done even better. Where do we go from here?
A positive policy shock between now and mid-late January seems unlikely. And it is very difficult to understand what will happen next in Russia and/or what will happen next with respect to OPEC, Saudi Arabia and the oil price shock. Positive outcomes seem very unlikely. So for me the pressure that has weighed on markets over the last two weeks seems likely to continue.
Of course the facts can change, and even more certainly interim bounces can and do occur. But on balance I think the key level to focus on is unchanged from my notes of September and October – a weekly close at or below 1905 on the S&P. This is my first target in this current risk-off leg. It would also mean much weaker equity markets globally (the US markets are a relative safe haven), much stronger core bond markets globally (sub 2% 10yr Notes), the iTraxx XO index well above 400bp, and some reversal in the USD’s strength (the DXY index is already off by 1.5 points from its early December high of 89.5, with 86.5 my next target). And if we get a weekly close in the S&P below 1905, and in particular consecutive weekly closes below this key level, then the October lows (1820 on the S&P) would be the next target. This in turn would give me a target for 10yr Notes closer to 1.75%, the iTraxx XO index closer to 450-500bp, and a DXY index target of 85 or possibly even lower.
I realise that it is not normal to have a bearish risk view for December through to mid-January. Normally markets tend to ramp up in December and early January before selling off later in January. But this year I do think things are different. One look at the moves in core bond markets over 2014, when almost everyone I talked to had been bearish bonds, paints a stunning picture. I would entitle this picture ‘The Victory of Deflation’, or (as many folks now talk about (but still generally dismiss)) ‘The Japanification of the World’.
I may end up eating my words in 2015 if the US consumer does come through, but if he or she does not, then we may well need QE4 from the Fed to battle the incredibly strong headwinds of deflation around the world. And I will revert on this subject, but to me the coming ECB QE and more BOJ QE are woefully inadequate substitutes for USD Fed QE.
Lastly, and in order to protect myself over the next few weeks against a meaningful bounce (driven by a change in the facts most likely) my stop-loss would be a weekly close in the S&P above 2020 (a key level as per my last note) on a consecutive basis.
Good luck and a Merry Christmas and Happy New Year to all.
Wednesday, December 31, 2014
Monday, December 29, 2014
I will write a 2015 outlook note in the new year. I am still thinking about the key issues, namely global growth weakness and the disinflationary and deflationary winds blowing through the global economy, and how these key twin factors will affect global policy and global markets.
For now I continue to believe that four very strong deflationary factors are driving things – global indebtedness levels (which have gone UP since the financial crisis), demographics (rapidly ageing populations pretty much everywhere other than sub-Saharan Africa, the Middle East and, notably, India), technology (which is significantly disinflationary) and globalisation (whereby the average global worker has little or no pricing power).
As such, and with the above caveat that I will present my full views and thoughts early next year, as of now I see 2015 as more of 2014. Namely, a stronger USD versus the world, lower bond yields and flatter yield curves with long duration assets in core government bonds markets offering the most value, and much more volatility (I expect to see increased year-on-year volatility in 2015).
This volatility should make equities an unattractive place to be particularly on a Sharpe Ratio basis (2014 has been bad enough, but 2015 will I think be even worse). And in credit markets it will mean being much more invested in the highest quality assets and much less invested in the riskiest parts of the credit markets – namely USD EM credit and the US high yield market owing to the significant concentration of issuers and issuance in the vulnerable energy and energy-related sectors.