Mark Twain once observed that history rhymes, does not repeat. Definitely true in the case of Wall Street. I had argued that risk assets would struggle in April, if for no other reason than because I planned to exchange the green florescent glare of my Bloomberg screen for the ethereal light of the Sea of Marmara and the Bosphorus in the Easter hols. A classic case of history rhymes in the stock market. The S&P 500 corrected in twin 18-22 per cent bear markets in both 2010 and 2011, proving that April on the Med is a lot more fun than April long on the Big Board. The March nonfarm payroll was a shocker, Spain and China entirely predictable, the gold short since last $1,750 profitable (another $80-100 an ounce is my target), the Aussie dollar is a forex sad sack, the Queen’s at Ascot, an Old Etonian in Downing Street and all’s well with the world. But is it? Some caveats.
One, the US economy is not on the ropes, as the 0.8 per cent retail sales data demonstrated. Joe and Jane Sixpack have deleveraged with a vengeance and most US urban housing markets have bottomed. The US banking system is in its best shape in the past decade even as European finance has hit a Titanic scale iceberg and not all of Super Mario’s men and all of Super Mario’s horses can put the Old World banking Humpty Dumpty together again, though three year trillion euro free money helps postpone credit Armageddon. Double Dip in the US? No way, Jose! (pronounced the Spanish).
Two, sentiment was way too frothy since March and liquidity bubble rallies invariably end of tears. The China GDP/political shocks were as SOS for emerging markets and commodities, as I repeatedly argued prior to my Istanbul trip. Remember the bearish case for Hong Kong’s Hang Seng Index? Down 1000 Hang Seng points since the publication of the call. Spain was also entirely predictable after Rajoy’s dismal performance in the Andalusian election. This was the reason I argued the euro would trade at 1.30 even as we flirted with 1.34 and cable fail at 1.60.
Three, the Great Game for value, investment’s elusive holy grail. Is the US stock market undervalued? Absolutely not. Is it priced to reflect the myriad political/fiscal risks in Washington as the clock ticks closer to November. No. Yet no recession means no savage bear markets but plenty of risk asset corrections. Yep, history rhymes with 2010 and 2011 again.
Four, earnings. Alcoa means squat. Operating margins are the highest since Nixon plotted the Watergate cover up in the White House and Marshal Brezhnev’s KGB gerontocracy ruled the Soviet empire. This is unreal. This will not last. Sure, Reagan (and the Iron Lady) killed the trade unions and the Silicon Valley miracles spawned global supply chains that straddle the Middle Kingdom. Earnings/margins are now at risk.
Five, geopolitics looks a bit more positive, if the G-6 nuclear talks in Istanbul bear fruit, though Syria seems doomed to a tragic, protracted civil war and post Baathist Iraq’s centrifugal/sectarian demons horrifies me. Are the world’s black swan risk priced into the Chicago VIX? By definition, not so. But the wicked witch of Wall Street (momentum in market jargon) has now turned negative. Could the S&P 500 index trade at 1,280 before September? Yes, it could. I would rather wait for VIX 30 to generate lovely asymmetric put premium sales than try to bottom fish in a world where I see the storm clouds darkening. Just as they do on the Sea of Marmara when the palaces and kiosks of the Topkapi sea wall turn molten gold.
While the US economic momentum has slackened in the past month, I see no credible risk of Fed QE in the next month. This is the reason gold is mired in a sluggish $1,640–1,660 trading range. My natural conclusion is that disappointment with Fed QE makes higher US Treasury ten year notes inevitable. The UST10 now trades at 1.96 per cent. I believe its yield is headed to 2.25 per cent in the next month. A bullish FOMC economy forecast could take the UST10 yield to 2.40 per cent, as happened after the March FOMC. If the G-20 increases IMF funding, UST10 yields could even rise as high as 2.50 per cent.