The following is a letter to clients from RBS’ Chief Market Strategist Bob Janjuah that is making the rounds (hat tip Scott).
Dear All
I am deeply troubled by the world and markets. THIS IS AN UBER BEAR EARLY WARNING ALERT:…I know its not what folks in general want to hear but hopefully you’ll understand that I am trying to do my little bit to help….
First please refer back to my last comment, dd 26th April (Bob’s World: What an idiot!)….2 takeaways from this note in particular – 1) my bearish trading call on risk assets, looking for a 10%/10%+ S&P selloff over late Apr and May from the 1220 level, driven by sovereign concerns, was spot on – maybe not bearish enough!, and 2) the point of market and taxpayer revulsion with the horrendous Keynesian/monetarist nightmare forced upon us by policymakers has come to bear. Sovereign limits and sovereign credibility concerns are not now a future risk – they are HERE. The enormous failure here is that the private sector has barely had time to catch a breath, let alone develop any form of self sustaining private sector recovery, before these limits have already begun to hit home.
Before reading on the other item that needs to be highlighted upfront is the whole Inflation/Deflation debate. As I have been saying for many months, the TRUE underlying private sector trend is one of DEFLATION (balance sheet repair thru reduction of nominal debt levels). In my comment of the 26th, I capitulated in that I gave up on the idea of policymakers worldwide shifting to voluntary/pre-emptive tightening, and went with Kevin’s long held view – that policymakers would keep pumping and dumping in order to try and create inflation until the point of bond market and/or taxpayer revulsion, or until the point that inflation fears themselves become the major problem. As you will read below we now seem, at the global level, to be at or close to the point of bond market (Europe) and/or taxpayer revulsion (US). Alongside which the UK and China seem to be ‘voluntarily’/pre-emptively tightening, although in both these zones one could easily argue that INFLATION concerns are causing this tightening. Either way, the point here is that for now and for the next 6 months or so it looks like deflation will have the Upper Hand in the battle vs. inflation.
I still expect policymakers to come back – not yet, more likely in 6/9 months time – with NEW even more aggressive attempts to INFLATE likely thru fiscal policy (NEW China stimulus package by y/e?) and/or via a massive new Fed QE programme (see below). Thus – and whilst I have admittedly been wavering a little here – the outlook for govvies over the next 6 months IS bullish (USTs in the low 2s), but it is also clear that the Western world is NOT yet ready for multi-yr deflation and therefore the next huge attempt to reflate (around y/e?) could end up in a disastrous outcome for inflation and bond yields. But we can worry about this later – for now the winner seems to be deflation. Now, in no particular order:
A – Quite a few important global markets are now deep in official Bear territory – China is the obvious big bad one, but many other are there/nearly there.
B – Global Growth IS slowing and will slow hard into Y/E as stimuli impacts fade/are reversed…the street/market consensus is 4.5% globally, the reality is that the annualised run rate will be 2.5%ish into next yr and beyond…developed growth will be 1%ish, developing will be 4%ish (too many officials keep talking to me about a target of around 5%ish growth rates for China over the next few yrs but the street/market seems to ignore this)…Btw, China reval? R U joking??? Even a 1%/2% token would be a huge surprise to me.
C – We have policy tightening all over the world – fiscal (UK, Europe), monetary/credit/currency (China, US), regulatory (EVERYWHERE)…the market and taxpayer revulsion with Government recklessness is HERE! Europe in particular has signed off from the growth path and is now firmly placing itself in the Japan style multi-decade deflation/despair path.
D – For the EURO and Europe to regain ANY credibility and hopes for growth, Greece should be put into restructuring asap, maybe others too. The alternative is a black hole whereby wealth is destroyed in Northern Europe as it is sent to bailout unviable countries in the South. This grotesque misallocation of capital is a disastrous move for Europe/European growth. My HOPE is that the error of these ways is addressed asap. My FEAR – as seemingly supported by the political noises out of Europe over the last few days – is that when, come Sept/Oct, once we all realise Greece is badly failing its budget austerity targets, the politicians in Europe again usurp the sane eco based voices and keep pumping money/wealth into a bottomless pit. The UTTER NONSENSE that is now consensus is that the EURO fails if its weakest leg is allowed to fail. I’m sorry but this is RUBBISH. The EURO and Eurozone will fail if the ECB is made a tool of politicians (maybe already too late on this front – all ECB credibility & independence is seemingly LOST). And the EURO and Eurozone will fail if ECB and Eurozone policy is dictated by the weakest link (Greece) rather than the strongest link (Germany). Again, maybe its too late on this front too. Lets see what happens when Greece is seen to be running an annualised deficit/GDP ratio closer to 20% than 10% come Sept/Oct, once we all see little progress on cuts and huge shortfalls of (tourist based) revenues. For now, the Eurozone has joined the club currently only occupied by Japan since the late 80s/early 90s.
E – The political situation in the US is turning/will turn deeply RIGHT – the Tea Party folks will have a huge say on how the US is run post AND into mid-terms. These folks are NOT elitist Republicans, they genuinely want smaller deficits, a weaker Washington, smaller govt. overall, and they want to attack the Fed….
F – Policymakers are (nearly) all in, some have lost all credibility (clearly Europe currently dominates this loss of credibility right now), others are close…
G – Technically, the set up of markets looks VERY BLEAK
Dear All – its seems to me that:
A – Risk markets can stabilise/rally a tad this week, perhaps a little into the week after, but overall there is a decent chance of a VERY SERIOUS risk asset sell-off late May/early June into late June/early Jul….I am talking ANOTHER 10%/10%+ off S&P from here….
OR
B – After more weakness into late May/early Jun, we can then see some stability over JUNE, before a MAJOR 10%/15% PUKE begins in/into Jul
Sorry I can’t be more precise, but net net it seems clear to me that the key risk here is of major risk asset sell off, with (eventually) S&P into the 800s, iTraxx Crossover up at 750/750+, a 5/10 big figure EURO Puke vs the USD, a broad USD rally, and 10yr USTs down at mid/low 2% levels. Whether we see a small bounce next week before the big selloff, or whether we see another week of weakness, followed by a month of ‘strength’ and then the big puke is not I think particularly crucial – the overall trend is the key. And in this respect, whilst following either of the above routes would then lead to a brief multi-month period of consolidation, the overall trend for the rest of 2010 will be weaker with respect to growth & risk assets/markets, and higher with respect to volatility. Key levels are (S&P cash) 1180 to the upside (and then 1220) and, to the downside, the 1020/1040 area. If we close below 1020 S&P, it would be very negative, implying that a mid-to-high 800s S&P is right around the corner…
How can we fix/avoid the nasty double dip in both the global economy and in markets? Well, it seems very difficult and there is no easy route:
A – Globally, the corporate sector would need to go on a huge spending/leverage/capex/hiring binge – this seems extremely unlikely…
B – China goes on a huge fiscal/Credit binge – again this also seems VERY unlikely, at least for now…
C – The US goes on a huge new fiscal binge (Hmmmm….if its going to happen it has to happen NOW, before the Tea Party hijacks Washington), and/or the FED moves to a 3/5trn QE programme…credibility destruction would be huge, the Fed would then be a MAJOR target for the Tea Party folks, and for me this IS the last bullet in the gun. I reckon the Fed would know this and would only use this bullet once we are in serious pain, i.e., the Fed would only go down this route AFTER the USD has rallied another 20%+ vs. the EURO/Others from current levels, AFTER 10yr notes are at low 2% levels and AFTER the S&P has already gotten down to the 800 level (maybe lower…)
SO, the asset allocation decision remains unch’d: QUALITY (driven by balance sheet strength, market position, and the ability to be a PRICE SETTER and NOT a price-taker) should drive all investment (as opposed to pure short-term trading) decisions.
Quality is now key in any investment (as opposed to ‘trading’) decision. Lets see if Europe sees sense come Sept/Oct. And lets see re the Fed, but please don’t forget you heard it here 1st – policymakers will NOT like deflation, and the last real roll of the dice will be (I think) late this yr/early next, when (I think) the Fed goes to a new QE programme in the order of $5trn. But because this IS the last roll, it will happen LATER, rather than sooner, and only when the pain in markets (equities, credit) and the economy is already excruciating. At which point we had better all hope that bond markets don’t react BADLY, because by then we will be ALL IN. If bond markets do revolt/react badly (as I fear) we will then very quickly be ALL OUT!!
Cheers, Bob
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Addendum: For a similar but alternative view read the last eight bullets under "So, what does this mean for the American and global economy?" In my October 2009 post, The recession is over but the depression has just begun. Still on track.
Read more: https://www.creditwritedowns.com/2009/10/the-recession-is-over-but-the-depression-has-just-begun.html#ixzz0orflkgYZ