Look, here’s the thing you need to understand about Citi: there’s an epic internal struggle going on between the equity folks and the credit folks.
You can read about it here. The equity desk is bullish. Matt King’s credit team thinks that may be insane given the looming QE cliff and what it portends for markets that have become dependent on central bank liquidity.
The bank’s internal meetings are probably a lot like Gangs of New York. Or like the fight scenes in Anchorman.
I don’t know where Jeremy Hale stands on all of this. He’s the bank’s head of global macro strategy, so maybe he just sits back and takes bets on the fist fights.
All I know about Jeremy is that on Monday he’s out with something called “Five Worries For Equities.”
If you’re still long stocks at this juncture, then God bless you for hanging in there and here’s hoping that your justification for sticking around has something to with an unshakable belief that central banks won’t ultimately pull the plug, because that’s about the only rationale that makes any sense up here.
For those interested, here are the five things that keep Jeremy Hale (but probably not Robert Buckland) up at night…
Sentiment: Our NISI Index (news implied sentiment indicator, Figure 1), has fallen sharply into bearish territory in the latest print, to its lowest level since end January 2016. As we have highlighted this year, as Trump “Optimism” fades, there may have been too much spirit priced into the SPX. The latest print in NISI suggests renewed skew towards pessimistic sentiment and thus looking at past correlations to the NISI, the SPX may fall relative to trend for a period on this measure.
Valuations: Arguably already rich and perhaps increasingly reliant on earnings to do the “heavy lifting” from here. Breaking down the P/E ratio to P vs. E illustrates how much the market has re-rerated significantly in the last couple of years (Figure 2). Even value stocks are expensive in the US. Additionally, estimates for the current ex-ante ERP are starkly below average historic excess equity returns of +4.7%. In order to even achieve this mean level of excess return, we’d need to see a nominal gdp growth rate of >5.25% (which would be above trend on a 5y, 10y and 30y basis). As such, this would require significant upwards revisions to Citi’s current growth outlook, at a time where Citi Economists say they are close to the cyclical peak in global growth and see increasing downside risks to their forecasts. Combined with undershooting inflation/ declining inflation expectations, this seems even more unrealistic and makes equities appear richer on this basis.
Earnings Outlook: We have no doubts 2017 will indeed be a positive earnings year, but the key is for this to also transpire next year globally. This will require the feed through of higher oil prices (due to the commodity sensitive UK and EM EPS). Whilst Citi currently forecasts higher oil prices, we note that the strong base effects witnessed more recently are slowly rolling off as we move past the oil trough in a one year rolling window. Meanwhile, spot oil prices are trending lower. And earnings surprises have been strong in commodity related sectors. So we need to see earnings strength broaden out heading into 2018.
Liquidity: As Matt King points out, a global shift to tighter monetary policy next year may be quite threatening to risk assets, given how important unconventional monetary policies have been for markets in recent years. His chart, which plots risk asset momentum vs. global central bank asset purchases in a 12 month rolling window, suggests in the event that all major CB’s shrink liquidity together, the implied path may see stocks correct -30% (Figure 3).
Other Asset Classes: As Figure 4 & Figure 5 show, it’s not just equities which are rich in valuation terms. Term premia in long end $ rates remains compressed and close to all-time lows. Our credit FV models also indicate that spreads in $IG and $HY are rich, to a magnitude of > 1 std. deviation.