One of the great things about the current environment is that it’s become so cartoonish that it gives enterprising analysts a license to troll.
After all, it’s not our fault that accommodative policy has morphed into a caricature of itself over the course of the last nine years and it’s not our fault that the geopolitical environment is now inhabited by a cast of characters that look like they jumped out of an Austin Powers sequel.
Everyday, the market looks at itself in a funhouse mirror. The reflection is “real” but the distortions are such that what’s staring back is a Salvador Dali painting complete with cryptocurrency bubbles, Shiller P/Es stretched to historical extremes, € HY trading inside of U.S. Treasurys, and central bank balance sheets stuffed with everything from copious amounts of sovereign debt to corporate credit to JPY16 trillion in ETFs.
And it’s the same thing with geopolitics. The world looks at itself in the mirror and staring back are a bunch of cartoon characters – even the most rational heads of state now wear Chewbacca socks to Bloomberg panel discussions.
This is the perfect setup for the boiling frog effect to take hold. And that’s just how SocGen is out characterizing things on Monday. “In a goldilocks scenario of low interest rates, abundant liquidity, stable growth and a focus on the ‘good’ Trump, investors continue to push asset prices, volatility and leverage to historical extremes,” the bank writes, proving yet again that everyone has given up on trying to pretend like the U.S. isn’t being run by schizophrenic, geriatric buffoon. They continue:
The parable of the boiling frog refers to how a frog in a pot can get slowly boiled alive without even realising it. The frog is so comfortable as the water gradually warms up that it is unaware of the danger it faces and ends up cooked. Today’s current dynamics put the US equity market at a similar risk as the frog.
Over the next 12-18 months we do not expect the market to crash or a financial crisis to ensue. However, we believe that the S&P 500 is showing an asymmetric risk/reward profile and we expect a flat price movement from here. A bear market is not so far in the distant future though, as we forecast a decrease in the S&P 500 to 2000 by end-2019.
When the bank plots the residual from the S&P versus their model (which is based on 1/US dollar, 2/earnings growth, 3/earnings momentum, 4/US CPI year-on-year change, 5/cyclically adjusted P/E ratio, 6/dividend yield spread, 7/NYSE margin debt, and 8/M&A deals), this is what pops out:
As SocGen goes on to write, “the current residual is obviously a reflection of a lack of momentum in the model inputs relative to the index and makes sense when the market is reacting to expectations (which are the same as saying that the model inputs are mostly backward looking).”
Right. In other words, people may very well be extrapolating an unrealistically benign environment going forward. Perhaps most worrying is that when it comes to the model inputs, the bank notes that “the model sensitivity of the S&P 500 to NYSE margin debt rose between 2013 and 2015.” And while it’s stabilized since then, that certainly seems to suggest that margin calls might play a role in exacerbating any future drawdown:
So you know, come on in… the water’s warm… and it seems to be getting warmer…which should be fine…
