Investors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
Read MoreFinancial journalists have had to resort to clichés in the past few weeks to describe the reality that they’re being paid to report on. At the start of December, Financial Times’ Robin Wigglesworth invoked the “everything rally” to describe a market "too hot to handle”, while Bloomberg’s Marcus Ashworth and Mark Gilbert have gone for the idea that markets will “defy gravity”, again, in 2021. The industry’s most widely watched investor survey— the BofA's GMFS—chimes in with the observation that "asset allocators are underweight cash first time since May’13; triggering FMS Cash Rule “sell signal,” a sentiment supported by the opening line in ASR’s recent study; “this is the most bullish result we have seen in the six year running our asset allocation survey.” The bull market in equities is paved with the irrelevance of such skeptical analysis, but sometimes the truth is in fact staring you in the face. This market is flirting with danger, and will soon suffer a significant correction. The more pertinent question, however, is whether I, or anyone else, have the tools or wherewithal to pick a tradable top, and following from that, whether a correction will mark the beginning of a more sustained downturn in equities, and other financial asset prices? As far as the first question is concerned, luck is a thing, but trying to pick even relatively obvious intermediate tops in this market isn’t easy. As a friend on the buy-side likes to remind me; “my put options are melting like butter in the microwave.” In terms of a more dramatic shift in the trend and narrative, we won’t be able to perceive it when it happens, but I don’t think such a shift is imminent.
Read MoreIt’s been a week on the wild side in markets, though amid all the confusion and commotion the main story is simple. The uplifting vaccine news from Pfizer has invited markets to consider how a world without the virus looks like. Taking the initial reaction at face-value, this is a world basking in the glory of reflation—and accelerating nominal GDP growth—higher long-term interest rates and a sustained rotation from growth to cyclical and value stocks. Let’s start with the obvious point. There is now a chasm between those basing their world view on an effective vaccine, and the end of Covid-19, and those staring down the barrel of a still- uncontrollable spread of the virus, and associated lockdowns to contain it. As far as the economy goes, forecasters now have to pass Fitzgerald’s test for a first-rate intelligence. The near-term outlook for developed economies is not pretty, and as restrictions encroach on December, the Q4 GDP forecasts are sinking without a trace. We’re currently living in a start-stop economy. The question economists have to answer is whether this situation has to be assumed for 2021? It’s certainly possible in Q1 and Q2, but Pfizer’s news has thankfully made such an outcome less likely. The problem is timing and whether we have to be on lockdown-lite through parts of H1, as we wait for the ‘shot’. The best case scenario is that the population at large gets the shot in the first half of the 2021, but that’s a Hail Mary. Take it from me, a professional economist whose day job it is to put numbers on the state of economy over the next six- to-12 months, we don’t know.
Read MoreI meant to publish this entry before I went on holiday, but time got the better of me. My initial impression of markets and the economy as I get back in the saddle is that I haven’t missed much. As such, after hitting F5 an awful lot of times to pull my spreadsheets into the present, I am left thinking about the same themes that I have since Covid-19 ripped up the script. Actually, I am pondering the same themes that I was mulling before the virus too. Economists and analysts are running out of ways to describe the current regime, but in a nutshell, the state of play is as follows. The virus was the straw that broke the camel’s back, prompting policymakers to double-down on the fascinating experiment they have been flirting with, in some form or the other, since the onset of the great financial crisis. How much fiat currency can be created before it either destroys capital markets via inflation, or perhaps more likely, sows political disaccord, if not outright kinetic conflict? I am neatly leaving out the prospect of policy actually getting it right, which is to say; the idea that a new equilibrium is obtained which allows monetary and fiscal policy to seamlessly leave the stage. After all, why would policymakers give up the power that they’re currently being offered by economic events? Luckily the answer to the first part of this question seems to be a very long time, and quite possibly well within the investment horizon for many investors. As a result, investors are being invited to pick up dimes in front of the proverbial steamroller, at gunpoint for added effect. History suggests that they will do just that, until something breaks.
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