Although markets ended the month on a more positive note, January was not kind for many investors. The current rally that began over a week ago is yet again predicated on more unconventional central bank policies. As noted last week, we are increasingly of the view that the law of diminishing returns is kicking in and that market rallies will be short lived and the economic benefits marginal, perhaps even negative longer term.
As we cast our net around the macro landscape, we see the following;
• Economic growth expectations are being downgraded everywhere except Europe.
• US equity valuations are extremely stretched and US$5.5 trillion of bonds trade with a negative yield.
• US Dollar liquidity is tightening.
• Geopolitical worries are bubbling away in Europe (including the Brexit issue), the Middle East and the South China Sea. Russia is in recession which is never a good thing and the US elections remain fluid.
• Assets that do appear to offer value are becoming extremely stressed.
With global economic growth struggling in the face of structural headwinds, it is the political leaders of the world that need to get to work. Broadly speaking, they continue to delegate their responsibilities to central bankers who are now collectively in so deep we really don’t see any easy way out. The current predicament of the Fed trying to tighten policy as their economy slows is a good example. It is perfectly feasible that those central banks with negative yields will find it much harder than the Fed when (if?) it comes to exit.
In simple terms, markets can be viewed as a great tug-of-war between the poor macro background highlighted above and the unconventional policies of central banks. Every time the poor macro fundamentals appear to be gaining the upper hand, central banks fight back. The result may appear to give the central banks the upper hand, even if only a while. This keeps alive the “don’t fight the Fed (or ECB or BoJ)” narrative. The reality is different, equity markets have made no progress for a period of time that can now be measured in years, depending on which index you look at. It appears to us that at best the opposing forces are evenly matched, and the negative macro forces are gaining momentum.
The short term question is how long and how far the current rally will last? If our bear market thesis is correct, then we should not expect more than a few more per cent of upside over the next couple of weeks or so. The chart below of the S&P 500 (which we will use as a general proxy for equities) illustrates what we believe to be structural resistance. In a bear market, we would not expect price to meet or exceed this area.
Chart 1 – The S&P 500 with structural resistance
We will keep it short this week, as we don’t think there is much more to add on markets. Risk assets are rising on yet another central bank policy that elicits short term excitement in markets, and little else. We are working on a more detailed note about why we think that Central Banks are potentially making things worse in the longer term. In the meantime, we are trying to be patient in re-entering our bearish trades, which we are itching to get back on.
You may wish to see Stewart in action on a Bloomberg panel on Friday discussing the BOJ surprise, the impact of the low oil price and top trade for 2016. You can view videos of these discussions via the following link.
Stewart Richardson on Bloomberg TV Panel Discussion – 29th January 2016
Stewart Richardson
Chief Investment Officer
