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Bob Janjuah's "Interim Capitulation" Line In The Sand

Via Nomura's Bob Janjuah,

I am glad I got my last note out on Tuesday this week! The key market outlook from that earlier note was:

So notwithstanding that my 1905 S&P 500 level is key, what would I do now? It seems to me that unless we get a major unexpected policy and/or sentiment shift this week, the S&P 500 will close below 1905 this Friday. I would then target 1770 as the next stop. This would lead to UST 10yr yields at or below 2% and the new iTraxx XO index would then trade well above 400bp, perhaps closer to 425bp/450bp. And if the S&P 500 also fails to regain 1905 by next Friday’s close (24 October), then I think it is entirely possible that by late November the S&P 500 could take out not just 1660/1650, but also perhaps 1600/1570. This would take UST 10yr yields well below 2%, perhaps as low as 1.75%, and we could see the new iTraxx XO index closer to 475bp/500bp. Throughout all of this I would expect the USD to sell off a little vs the global basket.

 

Clearly, the last 48 hours has seen significant price moves and my shorter-term targets have been hit already – UST 10yr yields have traded below 2%, the new iTraxx XO index has traded at 430bp and the USD is weaker. The S&P 500 has not quite hit 1770 but since my note it has traded down from 1899 to 1821. The 1770 level could be taken out today or tomorrow. And, of course, the S&P 500 is merely a proxy for “risk-on” – most other equity markets, particularly in Europe, have been much weaker.

 

 

My confidence that we avoid an S&P 500 close above 1905 this Friday is extremely high, as it is for next Friday. As such, I remain confident that by the end of November there will be further risk-off moves that will take UST 10yr yields to 1.75% (or maybe even 1.5%), USDJPY closer to 100 than 105, the new iTraxx XO index up to 475bp/500bp, and the S&P down to 1660/1650, possibly as low at 1600/1570. It would take a sudden unlikely sentiment and/or significant policy shift to force me to re-assess these targets, again with the 1905 weekly closing level on the S&P 500 as my pivot point. 

So no change. In this note I focus on two things:

1 - We all hear nonsense in the course of our lives. Sometimes we talk it. Over the past 48 hours I have heard that this apparently unforeseeable re-pricing of global markets is down to Greece, down to Ebola, and/or down to the fact that the street is not offering much liquidity. However, I think the re-pricing was foreseeable and has – so far – barely anything to do with these first two items. At some point I’m sure the market will accept that the re-pricing is much more about reassessing global growth and deflation expectations and collapsing policymaker credibility.

And as for the liquidity argument – which HAS been a factor, in my view – how can this be a surprise? After all, as I see it, one of the cornerstones of regulation over the past five or six years has been to ensure that banks are unable to provide liquidity when clients really need it en masse. Providing so-called liquidity when nobody really wants it and when everyone is buying risk without fear is easy. But every market participant should have had it drummed into them by regulators over the past few years that the sell-side will not be there precisely when liquidity is required en masse by clients.

Risk bulls have always talked about the lack of leverage in the system. They failed to understand that the size of positions on client balance sheets vs the levels of real liquidity on offer from the sell-side which can facilitate risk transformation or portfolio rebalancing represents the new “leverage” in the system. This mismatch – in market panics – runs probably into double-digit multiples. And I don’t see it getting any easier/better.

2 – This week feels like INTERIM capitulation. So I feel that the probability distribution now favours a short-term three- to seven-day period of RELATIVE calm/counter-trend bounce/easing-off of VOL spikes, over next week/the early part of the week of 27 October. I fully expect the market to convince itself that in two weeks’ time the FOMC will deliver us all some relief. 

I say interim capitulation because I think the Fed will likely disappoint at the FOMC meeting at month-end: it may leave the stub of QE open, it may talk about data-dependency and options, it may even highlight (global!) growth and deflation risk. But I firmly believe that for the sake of its own credibility the Fed will not say or do enough to satisfy the market’s plea for more help.

As the market is pleading for help which I doubt the Fed will give (yet), I would focus on the ECB and the BOJ. I think the Italy/Bund 10yr spread needs to get to 250bp or so before the ECB can “act decisively” (i.e. outright QE). In other words President Draghi will need to convince Chancellor Merkel that break-up risk is back on the table before she gives him the go-ahead for outright QE. And USDJPY needs to be a lot closer to 100 before the BOJ can act earlier than expected.

Unfortunately, I think that by definition it will require another round of panic and capitulation in November, perhaps prompted also by another strong NFP (lagging indicator, of course) as well as disappointment with the Fed at month-end. A strong NFP would be bad for risk as markets would have to price out any immediate Fed help even further into the future. So the ECB and the BOJ appear to be the only (semi-) credible saviours, but the pre-conditions they require before they step up, highlighted above, means that first we need to see much more panic and capitulation, over November. 

Beyond this week and through to 29 October, where the short-term counter-trend multi-day bounce is my central probability, I would use this period as a time to sell risk, and to reload and get both short stocks and long USTs/Bunds again for the capitulation I expect to see into late November. For non-traders, stay short risk (subject to my 1905 caveat) and long USTs/Bunds through to/through November and until we price in major measures from the ECB and BOJ, which should hopefully be sufficient to turn sentiment and markets around in December. For those who choose to stay short risk don’t be too surprised by some relative calm/counter-trend bounces as a possible theme for next week/into 29 October, at which point I expect the Fed to fail to deliver what the markets want to hear.

One last point – QE4. I received some pretty critical feedback when I said that, over the next 12 months I saw a 50/50 chance that the Fed would be EASING monetary policy vs commencing a hiking cycle. I still think it is 50/50 because the events of the past few days and weeks are not a surprise to me. What has surprised me, however, is how many people are now openly talking about QE4 and no Fed hikes until 2016/2017 – a complete turnaround from the consensus only three days ago. My key point here is that I do not believe the Fed is going to do anything substantive on the easing front (other than as discussed above) anytime soon, but over the next 12 months 50/50 seems a fair assessment to me.