Unfortunately, the stand-out move in markets since my last report—the crash in oil prices—is one on which I have little to say, let alone expertise. I didn’t see it coming, and I am not exactly sure why it happened. That said, I am not here to make excuses, so I’ll try to connect the dots as well as I can. A sudden fear of over-supply due to a shift in OPEC policy doesn’t seem to cut it as an explanation. I am more inclined to buy the idea of linking it with the jump natural gas prices, deeming it an erstwhile winning spread-trade gone wrong, at least in part. Pierre Andurand’s name has been mentioned too, which certifies that this has been a real rout in the oil market. Mr. Andurand’s $1B commodities fund reportedly shed a cool 20.9% last month. Whatever the causes of the swoon in oil, it serves as a decent entry the broader market discourse. I am sympathetic to the argument by Cameron Crise, a strategist with Bloomberg, that “Recent energy-price mayhem is just the latest sign that something about these markets looks broken.” Cameron goes on: “The presumption of a continuous liquidity spectrum is clearly an errant one.” Most readers of these pages will have plenty of recent examples that fit this picture, so I’ll jump straight to the grand conclusion.
Read MoreIf you are an equity investor with time to read this, I reckon that I should have the decency to cut straight to the point. Based on macro liquidity indicators, I see a convincing case for a short-term bounce in global equities into year-end, before—unfortunately—further weakness in Q1. The main argument is summarized in the two charts on the following page. The first compares momentum—the 2nd derivative of y/y growth—in global equities and global real M1. I am working under the assumption that the year-over-year rate in the global stock index will decline gradually to -10% by the end of March. Adding back into the price points to just under 6% upside between now and the end of December, before a nasty 11% drawdown in the first quarter. This story is supported by the idea that higher yields and rising oil prices are now a significant challenge to multiples, especially in the U.S. Abee makes a similar point over at Macro Man, with the ominous addendum that it’ll probably get worse if growth in earnings falter, which they are liable to do, eventually. The argument for a short-term bounce is straightforward. At the time of writing, the global equity benchmark is down nearly 10% on the month in October, and about 5% for the year. I never thought that this would be a particularly good year for equities, but this seems like an excessive reaction, after all.
Read MoreAs sell-side strategists parse the entrails of positioning data, and update their greed & fear models, to guess whether markets are due a rebound, investors should not forget the big picture. The conditions for further weakness remain in place. On the macro-level, the sharp slowdown global liquidity has been warning for a while that global—more specifically U.S.—equities had been rallying on borrowed time. Closer to the ground, the sell-off suggests that the multiple-crushing rise in bond yields and oil prices finally got the better of risk assets. The perma-bears will tell you that this is the drawdown to end all drawdowns, dragging global equities down to the netherworld of 2008 and 2009 price-levels. They have absolutely no justification for making such a call, but it won’t stop them peddling this narrative. Prudence suggests that we keep a close eye on liquidity in the credit market and, more specifically, signs of illiquidity in corporate bond funds and ETFs. The short-run is anybody’s guess, but if the recent past is a guide, it’ll go something like this: The market will rebound, eventually, retracing about half of the initial plunge. It will then roll over again, making a new low—the classic double-bottom—which can be bought aggressively.
Read MoreThe easiest way for U.S. bond markets to entice investors to abandon their obsession with a flattening yield curve—and whether it’ll soon invert—always was to steepen it. The spreads between 5y/10y and two-year yields have widened to 17bp and 30bp, respectively, about 10bp wider than at the end of August. More importantly, this move has occurred as a result of higher mid-to-long term yields. A few basis points don’t make a trend, but the combination of U.S. 5y and 10y bond yields pushing above 3% introduces a number of erstwhile dormant narratives into the mix. Perhaps the mythical neutral, or terminal, rate is higher than the Fed and markets think? Fed Chair Jerome Powell admitted recently that the FOMC probably doesn’t know where this rate is. This argument makes little sense in the context of the dots, which seem to imply that a policy rate of a bit over 3% in 12-to-18 months time is deemed restrictive. But it makes sense if this signal is no longer relevant for markets. The always optimistic David Zervos, the Chief Strategist for Jeffries, detects a shift at the Fed. “The most important takeaway here is that the probability of an aggressive late-cycle curve inversion has plummeted. (...) Maybe Jay goes there if we start ripping toward 3500 in spoos, but it won’t be because of the inflation or growth data.”
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