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"S&P < 1870 Until QE4 Or China QE1" - Seven Observations On The Fed's "Shocking" Announcement

Three days ago we posted a prescient note by one of BofA's only worthwhile strategists, Michael Hartnett, who warned that the market "Ominously Hints Recession Imminent" Unless "Unambiguous Pessimism" Leads To Stock Rally." Since then things have gone from bad to worse, because not only are market participants still extremely pessimistic, they just saw the Fed do the most dovish announcement in years, only to see the market selloff further, thus adding to their pessimism, and brings us one step closer to the "recession" and "default" hinted earlier in the week.

So is a recession imminent?  According to Hartnett, the answer is simple: if despite the massive pessimism overhang and the dovish Fed, the market can't stage a rebound, the answer is a resounding yes.

That's not all. In a note titled "The Fed Blinks", Harnett does a FOMC post-mortem in which he observes, correctly, that the "Fed admits China/Wall St threatens to reverse Main St recovery", in other words Wall Street, as in Goldman, won, Main Street lost. As usual. 

Some other big picture thoughts form Hartnett:

  • Fed confirming “deflationary recovery” (Chart 1); risk can rally but sell into strength; upside for risk assets constrained by growth outlook, downside protected by Fed. Fragile Wall Street + perilous China = “tactical delay” in Fed hike according to our economists; BofAML say Dec hike likely; but if no autumn risk rally despite ultra-dovish Fed & bearish sentiment = markets hinting “recession” and/or “default” imminent.
  • Short-term tactics: negative for US$, banks. EM>DM, resources>banks, gold>US$, REITs>cash, growth>value decent tactical trades.
  • Deflationary recovery means “growth”, “yield”, “quality” remain structurally bid; we stay long US$, volatility, real estate & stocks>bonds; but SPX>2040-2070, GT30>3.2%, DXY>97 needs stronger global growth in Q4.
  • Bearish risk = deflationary bust: Asia banks indicate crisis; Q3 EPS recession. FMS says Discretionary, Banks, Tech & Eurozone most at risk should peak liquidity coincide with EPS recession…

And here are his full 7 observations in the aftermath of what may be the Fed's first official "policy error":

The Fed left rates unchanged at 0% to 0.25%. Thoughts…

1. Fed admits China/Wall St threatens to reverse Main St recovery; Fed confirming “deflationary recovery”; risk can rally but sell into strength; upside for risk assets constrained by growth outlook, downside protected by Fed.

2. Stay of execution for “liquidity era”: nonetheless liquidity has peaked (Chart 2). And peak in liquidity = peak of excess returns = trough in volatility: annualized returns between start of QE1 (3/9/2009) & end of QE3 (10/29/2014)…stocks 20%, HY 18%, REITs 31%...(Table 1); since end of QE3, returns much, much lower, volatility higher & flash cashes (oil, UST, CHF, bunds, SPX) more common.

3. No hike, no rally: fragile Wall Street + perilous China = a “tactical delay” in Fed hike according to our economists; but if no risk rally despite ultra-dovish Fed & bearish sentiment = markets hinting “recession” and/or “default” imminent: allocation to risk hindered by growth fear (China, global PMIs), default fear (EM, commodities, Wall St), and liquidity fear (bonds/stocks "untradable" right now). Stronger global growth best antidote to fear: US payroll/retail sales & Chinese exports now key data (nb latter has tough comps next 2 months).

4. Short-term tactics: negative for US$, banks. Stocks>bonds but SPX>2040-2070, GT30>3.2%, DXY>97 needs stronger global growth; EM>DM, resources>banks, gold>US$, REITs>cash, growth>value all good tactical trades.

5. Big picture = deflationary recovery: Fed confirming “deflationary recovery” status quo (Chart 3); no recession/bankruptcy thanks to low rates/oil/unemployment; but expansion remains deflationary thanks to debt, tech disruption, demographics.

Deflationary recovery means “growth”, “yield”, “quality” remain structurally bid. We stay long US$, volatility, real estate & stocks>bond, but upside for risk assets now constrained until unambiguous handoff from liquidity to growth.

6. Bullish risk = reflationary recovery: if the Fed’s failure to hike does not lead investors to completely abandon hope on growth and scurry into gold, cash & volatility, “barbell of 1999” could reemerge: Über-growth & Über-value massive outperformers post-Asia crisis.

7. Bearish risk = deflationary bust: Asia banks indicate in coming weeks markets at early stage of crisis; Q3 EPS shows recessionary global economy. Crowded Discretionary, Banks, Tech & Eurozone (Chart 4) most at risk should peak liquidity coincide with EPS recession, SPX<1870, GT30<2.8%, DXY<93...at least until new extreme policies introduced (Fed QE4, China QE1 or a G7 shift toward  fiscal policy stimulus).

And here is BofA's "bearish risk" punchline:

  • SPX<1870, GT30<2.8%, DXY<93...at least until new extreme policies introduced (Fed QE4, China QE1 or a G7 shift toward fiscal policy stimulus).

And there's your bogey: push the S&P down another 100 points, and wait for the Bullard to be unleashed, only this time his jawboning will have to be backed with actual money printing. The good news is that Fed credibility is now virtually non-existant, and the next QE will be the last. Then, the paradrops begin.