JPM’s head quant, Marko Kolanovic, who from a chronic market skeptic has in recent months morphed into a raging bull, is out with a note in which he not only first mocks the bears…
Recently, financial press stories were dominated by fear. This is perhaps understandable given a long period of extremely low volatility before the recent turmoil. Negative stories also tend to attract more attention (clickbait). After running through various negative narratives – inflation, stagflation, hyper growth, rollover of growth, large deficits, tariffs to reduce trade deficits – the most recent bear narrative is trade wars (and particularly one with China).
… only to tease them by forecasting new all time highs…
We argue below that this risk is also very low, and if we take the 2015 turmoil as a template for flows from systematic and fundamental investors, markets are likely to reach all-time highs soon.
… even as his JPM cross-asset colleague John Normand warns that the time to sell may be approaching, now that the odds of a recession inside 3 years are over 70%.
Or, as Kolanovic would see when looking at the Rorschach test above, just the right conditions for all time highs.
More interesting is the JPM quant’s assertion that Trump will – or should – avoid launching a trade war at all costs, not least of all because he wants to avoid impeachment, which would be far more likely if Trump “destabilizes global markets” impairing the administration’s ‘market scorecard’ and likely leading to an election loss. And, as Marko adds, “lost elections open a path to impeachment, and other complications.”
Which is clearly a sensible thing to say for any bank employee, whose bonus would be similarly “complicated” if Trump “destabilizes global markets.” As for the “revelation” that a market crash could Trump the midterms – and potentially his liberty – well, that’s been the plan since November 8, 2016.
Here’s Marko:
A significant trade war started by this administration would destabilize global equity markets. Should this happen ahead of the November election, it would impair the administration’s ‘market scorecard’ and likely lead to an election loss. Lost elections open a path to impeachment, and other complications. The game is also non-zero sum, as one can both use tough rhetoric and at the same time do little disruptive action (e.g., players as we defined them can ‘have their cake and eat it’). Setting up a diagram (similar to the well-known ‘prisoners’ dilemma’) points clearly that there will be strong rhetoric, but weak or no action that would destabilize equities.
One could argue that a similar analysis can be applied to the risk of the Fed committing policy errors (see figure below, asymmetry in the case of the Fed would be causing a recession, and the public pinning the blame to specific individual central bankers responsible for the decision).
So after telling to the president that he should avoid a market crash if he knows what’s best for him, Kolanovic then goes back to prodding the bears, explaing that since there have been no further shockwaves from the record February VIX spike (which by the way Kolanovic said would not happen), what comes next for the market are fresh all time highs. To wit:
Unless there is a recession, all of these flows tend to reverse within 1-2 months. For instance, short-term momentum turns positive ~1 month after the initial shock, short-term options expire within a 1-month cycle (gamma rolls off), and realized volatility starts declining prompting volatility sensitive investors to buy. This all happened in 2015 and is happening again now. A very simplified price analogy is shown in the figure above, and suggests the market should reach all-time highs relatively soon.
Which, ironically differs substantially with what Kolanovic wrote at the end of January when he said that “In terms of timing market downside risk, we would be more concerned about the period after the Q1 earnings season, when fiscal reforms are likely to be priced in and central banks make further progress on the normalization of monetary policy.”
That would be right now.
Finally, the quant has one last card up his sleeve: if you don’t believe him, then believe JPM’s forecast of over $800 billion in stock buybacks:
There is also a substantial difference between Feb 2018 and Aug 2015. Right now, both macro (synchronized global growth) and corporate fundamentals (tax reform and record earnings) are much better than in 2015. This adds demand for equities and strengthens fundamental reversion flows. For instance, compare current fundamentals to 2015, when we had a US earnings recession, EM crisis, China crisis, Energy, and High Yield concerns. This year, we expect $800bn of buybacks vs. ~$600bn in 2015. The difference ($200bn) on its own, equates to all the value of all recent systematic strategies’ selling. And while systematic strategies will buy back most of what they sold, buybacks will not reverse.
Kolanovic is referring to this chart…
… which incidentally will never materialize if i) rates jump making debt-funded buybacks impossible and ii) if there is a trade war.
None of this matters to Marko, however, who is about as bullish as we have ever seen him:
This is all supportive of the market reaching new highs relatively soon (e.g., with the onset of Q1 earnings season), and is consistent with our previous fundamental and quantitative research.
And so we wait to find out: will Kolanovic be right with his new all-time-high prediction, or will it be Gartman’s turn to finally have a last laugh after his “watershed call” that the market has now topped.
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