“The Downside Tail Has Grown”

In all my many years observing and analyzing markets, I don’t know that I’ve ever seen expectations so disconnected from anything that even approximates reality.

Here we sit at historically elevated multiples…


(Charts: Goldman)

… with an 11 handle VIX…


In short, everyone seems determined to convince themselves that Trump’s economic policies will revive growth even as there are signs that some of the President-elect’s agenda (e.g. the imposition of punishing tariffs) might very well curtail the nascent economic expansion.

Even the Fed seems to be buying the narrative as the dot plot now points to three hikes in 2017 as opposed to two. That suggests officials are fretting over the possible consequences of adding fiscal stimulus to an economy that’s already at full employment (i.e. they’re worried about things “running hot” and about the possibility that policymakers may “fall behind the curve”).

And while Trump may indeed turn out to be good for growth (at least over the short-term that encompasses 2017, 2018, and 2019), his rise to power has also increased that odds of something horrible happening in the not-so-distant future.  Consider the following from Morgan Stanley:

Given the many political uncertainties that remain, the European Central Bank is unlikely to end quantitative easing until the second half of 2017. Although Brexit hasn’t dented EU growth materially, if the voter discontent that swept the UK in June and the U.S. in November continues its march through key ballots in Italy, France and Germany, financial markets wouldn’t be immune to the stress of such geopolitical uncertainties.

Hence, 2017 will feature a broader distribution of possible outcomes. “The gains in a plausible bull case look larger than before, fueled by the prospect of fiscal expansion, rising earnings and a return of true ‘animal spirits.’ But the downside tail has also grown,” Andrew Sheets, chief cross-asset strategist says.

And if you’re looking to Wall Street to help you out when it comes to predicting where we’re headed, here’s a piece of advice: don’t.

From Bloomberg:

It turns out that while strategists’ forecasts are remarkably close to the mark much of the time, they are woefully unreliable during inflection points. For example, strategists overestimated the S&P 500’s year-end price by 26.2 percent on average during the dot-com bust from 2000 to 2002. Then they underestimated the index’s year-end price by 10.6 percent during the early recovery in the first half of 2003.

It happened again during the financial crisis. Strategists overestimated the S&P 500’s year-end price by 64.3 percent in 2008 and then underestimated it by 10.9 percent during the first half of 2009. In other words, the forecasts were least useful when they mattered most.


But hey, just hold your nose and buy, right? After all, it’s worked well for the better part of eight years now.



Speak On It