Something has changed in 2016, as suddenly some of the big investment banks break ranks and start talking about how things may be ever so slightly wrong in asset markets, a development we see as very significant and not a little Bearish, perhaps much more so than the adverse market moves on Monday the 4th. However it is worth noting, as we look at the headline volatility, markets rarely begin a year with such unequivocally sharp moves downwards, indeed the last time there was a first day retreat in the UK larger than Monday’s was on the first trading day of 2000, coincidentally also a January 4th, the trading day after the market had reached a level it wouldn’t see again until 2015.
Now while these movements are unequivocally Bearish in themselves (and there is a strong relationship with negative first trading days and a poor following year) it is frankly a little surprising we don’t see them more often, with most year ends seeing forced buying in the shape of a “Santa Rally” (professional investors punting on driving markets upwards on thin volumes to improve their year-end figures) which should naturally translate into a profit taking impulse in January, particularly when valuations are as stretched as they have been over the last few years.
However yesterday’s mood was not helped by the clearly weak PMI data from many parts of the world, starting with Asia (although this was offset by Europe to a degree, as discussed HERE), rolling into Canada and then the US, where the ISM (Institute of Supply Management) PMI indicator came in well below expectations at 48.2 (remember 50 is the break-even line), a significant shock, while sub-factors within the figures pointed to further weakness:
Source: AG Click/Tap to Enlarge
However perhaps a more worrying aspect of unfolding events for markets is the change in tune coming from some of the biggest cheerleaders of the Bull market, specifically the large investment banks, with JP Morgan being quoted stating “the regime of buying the dips might be over and selling any rallies the new one.”
More importantly they discuss a number of key points: “Equities are not attractively priced anymore. On most metrics, P/S, P/E and P/B they are trading at a premium to their historical averages” (as we have discussed a number of times, for instance HERE and HERE) …. “Balance sheets are deteriorating with increased debt issuance used to finance record levels of buybacks….US profit margins are showing increasing evidence of peaking” (HERE)……“Fed tightening is happening very late in the cycle (HERE)…..More fundamentally asset reflation worked during ZIRP to help equities. This could start to unwind” (we agree but believe QE is the greatest stimulant discussed , among other places, HERE) …“Medium term the Chinese and EM backdrop remains challenging” (HERE and HERE).
Welcome to the common sense express JPM!
Even more interestingly a note from Bank of America Merrill Lynch, penned in December has come to light, explaining “Essentially Central Banks, by unfairly inflating asset prices compressed risk like a spring to unfairly tight levels. Unfortunately, the market is aware that the price of risk is not correct, but they can’t fight it and everyone is forced to crowd into the same trade. By manipulating markets they have also reduced investors inherent conviction by rendering fundamentals less relevant…….. This then creates a highly unstable (fragile) situation that breaks violently when a sufficient catalyst causes risk to rise. Overly crowded positioning meets a market with little conviction.”
They go on to point out that this violent movement is often followed by a violent reversal back up as investors remember their is a Central Bank to fall back on and the cycle continues. However as we have pointed out, ultimately when the market breaks properly and confidence is lost the internal technical’s could look very scary very quickly (discussed, among other places HERE), or as BoAML explain “..it becomes clear that the biggest visible risk to markets is a loss of confidence in this omnipotent CB put” (the CB put being the Central Bankers who are metaphorically placing a base on possible market loses).
So welcome to the common sense express BoA!
But wait a minute I see they say “the market is aware the price of risk is not correct”. Really? So what were all those big bank pundits doing popping up in the media and industry forums telling fund managers to buy shares doing? Those same pundits telling advisers and the public to buy the funds who are buying the shares that they are also promoting; what were they doing? Were they telling everyone that they weren’t buying fundamentals, simply mis-priced risk caused by Central Bank manipulation?
Not so far they weren’t and haven’t been….which is the point.
When the players who have benefited most from the absurd Bull run of recent years, against the faux-recovery that has been bought at the expense of absurd amounts of more debt start pointing out the deep and obvious flaws in the narrative you get the feeling the party may be running out of steam. The truth is that despite recent falls most markets remain fundamentally expensive, against a background of increasing risk.
That these key cogs within capital markets are now publicly agreeing with views we have held for sometime however provides us with little comfort, for if they remain on board the risks will just keep rising, potential rewards for conventional investing will keep falling and many innocents may suffer……again.
Remaining cautious, high in cash and heavily hedged against adverse markets (if possible) would seem prudent.