Former Lehman Trader Weighs In On The Issues As Investors Ponder An Uncertain Future

Back on January 31, Bloomberg’s Mark Cudmore wrote the following about what he perceived as an eerie silence from the bears:

I’m suddenly nervous about global equity markets and it’s not for any good fundamental reason. My concern is primarily driven by the fact that, for once, no-one else out there seems worried at all. It seems nobody cares.

As we noted at the time, bullishness was indeed rampant despite early signs that the cracks were starting to form. Cudmore’s January 31 piece came at the end of a month that saw a veritable avalanche of inflows into equity funds as the last bears seemingly capitulated under pressure from rampant bullishness fueled in part by optimism around what the Trump tax cuts would likely entail for buybacks and a late-cycle sugar high for the U.S. economy.

“A record percentage of Americans expect equities to rise in the year ahead, according to a Conference Board survey which goes back more than thirty years,” Cudmore noted, referring to the following chart:

Here’s what that chart looks like now:

Needless to say, Mark’s late January call proved remarkably prescient.

The bottom fell out just a week or so later and while the technical pressure from the VIX ETP implosion and subsequent forced de-risking by systematic strats abated, more fundamental concerns quickly emerged to pressure stocks anew. Those factors of course include trade war jitters, concerns about tech regulation and geopolitical angst.

Mark – who joined Bloomberg in 2014 after more than a decade trading FX and rates at shops including Lehman, Standard Chartered Bank and Nomura – has weighed in on a daily basis since then via his Bloomberg columns, but we wanted to bring you the following interview courtesy of Erik Townsend’s MacroVoices podcast.

This is from April 19 and it touches on all the topics that are front and center in investors’ minds.

Via MacroVoices

Erik: Joining me next as our second featured guest is Mark Cudmore, who heads up the Bloomberg Markets Live blog in Asia.

Mark, last time we had you on the program was just before everything blew up. Very much to your credit, you had written a piece almost immediately after we last had you on the program saying: Hey, the one thing that could really derail this equity market rally would be the breakout of a trade war. Needless to say, that’s one of the things that’s happened here.

But I want to start with a really high-level big picture. What would you say is going on? Is this about the trade war? Is this about the vol complex blowing up? Is it about bond rates? What is it that brought this on? And do you think this is just a correction right now? Or do you think we’re looking at the beginning of something much bigger?

Mark: I think we are just in the middle of a correction. And I think, overall, the structural story is still pretty positive. But this is a correction that may not be over yet. And you’re asking what drove this.

I think one of the things that happened here is that this is a market that was probably overdue a correction after such an extraordinary 2017 rally with no volatility. And suddenly we had a load of factors at once that were very relevant. And there were some dynamics that genuinely changed.

As you mentioned, trade war is my big worry for markets. That’s the kind of thing that I said could actually turn this into a proper bear market or recession. I’m still hopeful that we’re going to avoid a full trade war. But, obviously, it’s concerning how much tensions have been ratcheted up already so far. And that remains my big worry that this will end the cycle early.

On top of that, though, what really changed in January is we had the market get extraordinarily bullish. I mean, we already had seen great gains through all of 2017. And then suddenly in 2018, in January, the market went a little bit crazy to the top side.

So we suddenly had everyone get super-bullish at a time when we were seeing extraordinary tightening in US yields. The front-end tightening was the greatest we’d seen since the first half of 2008. And, obviously, we know how that year ended in the US.

And it was a real yield tightening as well. Because inflation really isn’t accelerating as much as some people would have you believe. Yes, it is ticking up, but the yield tightening was extraordinary.

So we had a real sudden hit to liquidity at a time when people had really got stretched at the top side. That left the market particularly vulnerable for something negative to happen. And, of course, then we got the negative catalyst.

And there are now several different strands to this. The trade is certainly one part. But, as you mentioned, there’s the tech story as well where there’s been quite a few negative dynamics in the tech sector. And there’s a worry that the tech sector might experience greater regulation and oversight in the years going forward. That means greater legal costs, greater compliance costs. It might even mean greater taxation.

And, since tech has been such an important part of the global bull market in equities, if tech is going to have a serious blow to earnings, well, that might undermine some other valuations.

But, all that said, despite the fact there’s a lot of reasons to be still concerned in the short term, and to still expect a lot more volatility in the months ahead, I think that the structural story remains very good.

So we may not have bottomed out quite yet for the medium term. But we probably will go on to make new record highs in the next year. And that’s because we still have those three background pillars that are always referred to.

Global growth is good. It’s maybe not accelerating anymore. It may have peaked out. But global growth is still overall strong. Asia is still very strong. And in the G10 world, no one is particularly exciting but no one is doing terribly.

Earnings have obviously been great. Again, there’s probably not going to be much upside from that going forward. But, certainly, earnings have been a very strong part of the story.

And finally, liquidity has taken a short-term blow in terms of the US yields tightening. But, overall, central banks are still pumping money into the system. Not the Fed. The Fed hasn’t been pumping money into the system for four years now. But the PBOC, the ECB, they’re both heading towards $6 trillion balance sheets. That’s quite incredible, really.

And, as I said last time I was on, the Fed is actually the fourth biggest central bank in the world in terms of balance sheet already. And the others are accelerating away from us. So there’s still liquidity coming into the system.

So those three pillars, overall, are positive. That’s why I don’t think we’re at the end of the economic cycle. And that’s why I think equities overall will make new record highs, probably later this year. Maybe next year. But that doesn’t mean that the correction is over just yet, in terms of the short term.

Erik: Now, some people have talked about a very vulnerable point below the market still — down around 25, 35 on the S&P. I know that several people have written about that, some of them covered on Bloomberg. Do you think that there is a risk of an acceleration there if there is a stop loss, effectively, in the market at that level?

Mark: It’s funny. Who would have thought that we might have had several acceleration points already? So I’m loathe to get too excited about one particular technical level on the downside. But, that said, I do think there’s probably reason to think we do have a little bit more downside in the weeks and months ahead.

I think one of the things that the market has struggled with in the last couple of months is that, because we had so little volatility last year, they are now struggling to adapt to themes that take months to play out. And they want them to play out in the space of a day or two.

Trade negotiations is a perfect example where this is an ongoing dynamic that’s going to ebb and flow. There’s going to be positive elements, negative elements. It might, overall, turn out okay.

I do buy into the argument that neither side wants the full-scale trade war and, therefore, there will be some kind of compromise. But we can expect to be in positive points, where it looks like we’re about to reach the end and then we’ll suddenly get a negative turn again. So I think that story will play out for a long while.

And the tech story is another one that will continue to play out for a long while as well. So I think that people have been trying to play these themes too quickly.

And another thing that plays into that is, because we didn’t have much volatility last year, a 2% move this year is suddenly causing panic. But this has become the new normal in terms of at least 1% moves will become the new normal. And, therefore, we need to not read so much into several-percent moves over a few days in one direction.

So, that said, I do think we’ll probably see lower levels again in the S&P and global equities. I’m not super-high conviction if that would be my base case, that we will probably see lower levels in the month or two ahead. But, ultimately, there will be some point when you can turn around for the long-term climb higher again.

Erik: Since we’re talking about trade concerns, why don’t we come back to the US dollar itself. Now, last time we spoke, a lot of people were making very bold high-conviction calls. Some of them dollar bulls saying: Okay, the bottom is in, we’re about to bounce dramatically higher. Others saying: Dollar’s about to crash, world is coming to an end.

Interestingly, ever since we last spoke, we’ve seen really nothing but a sideways consolidation pattern. The market is just trading sideways.

What do you make of the US dollar? And where do you see it going from here?

Mark: My view on the dollar hasn’t changed that much. And that was the view that, overall, I’m a secular dollar bear and I think there’s a long-term multi-year downtrend. But I did think in January that we were ripe for a proper bounce that might last for a few months. That bounce never came. And, as you said, in fact we’re slightly weaker. But really we’ve gone nowhere.

Unfortunately (this is probably a bit boring), but I’m in the same view that, overall, I do believe in the long-term dollar downtrend. The dollar’s dominance in global trade, in global exchange, is slowly eroding.

We’ve seen that in the SWIFT payments, where the dollar peaked out at 45% of global SWIFT payments. And now it’s down to 38%. And it’s a steady declining trend.

So overall we’re just seeing the dollar becoming slightly less relevant as the US economy slowly loses its dominant share in the world economy. It’s less than 25% of the world economy now. But that’s a declining number as China and India in particular are seeing such extraordinary growth.

And, with the dollar amounting to almost 63% of global reserves, I think that mismatch will slowly close over time. So I believe in the long-term multi-year dollar weakness.

That said, I’m still waiting for this short-term bounce. And I think 2018 can bring a very powerful bounce. Part of the reason for that is that US growth is one of the strongest in the G10 this year. It wasn’t last year, when people were bullish dollar and that went wrong.

And also, on the yield side — and this had to be real yields — in the US are extraordinarily positive, and very attractive. So I think that the real yields and growth arguments will be two of the key drivers.

And we might see the dollar see a powerful bounce of a few percent at some point in 2018. But ultimately it won’t be a turn in trend. It’s just going to be a bounce in the long-term downtrend.

Erik: Let’s come to interest rates and Treasury yields next. The last time that you were on the program, we had a few people starting to come out saying: Okay, bond bear market is on. But they weren’t that numerous. Now, since then, we’ve moved about 30 basis points higher on the 10-year yield and all of a sudden there’s just a chorus of voices saying: Okay, that’s it, it’s over, the jig is up, it’s all headed downhill from here.

Last we spoke, I think you were really not very much of a long-term bond bear. Has that changed at all? Have you been persuaded by the growing number of bears?

Mark: Not at all. I think it’s roughly the same story. At the time that we spoke last, I said I expect the long end to stay in a volatile range. And, overall, that we’d see further curve flattening as we go through the cycle.

We have seen a little more curve flattening since then. We still have a lot more to go. I do expect that the curve will ultimately invert before the end of the cycle. And that’s why I’m also not worried that the end of the cycle is that close. It’s probably going to go to 2020 or so, based on historical precedent, in terms of the curve signal.

So I do think we’ve got about 45 basis points of flattening to go between the 2-years, 10-years. And I expect that to happen over the months ahead. But, again, this is not something that happens in the next few weeks. It’s something that happens over a many-years process.

I do think that in the 10-years, when we last spoke I said we could see spikes up to 3%, and we’ve seen those kind of spikes. Maybe the range is even higher than I thought. At the time we were speaking I didn’t state this, but I was kind of thinking that 3% is probably toward the top end of the range — maybe perhaps the top end of the range in 10-years. Probably more, maybe 3.2%.

But I think the overall dynamic is still there, that I expect 10-year yields to bounce around the range but not really go anywhere. I think the structural disinflationary pressures are just too large.

And that’s coming from technology, from demographics, and also from the fact that we just still have this liquidity in the system. Which is I think just going to keep on chasing yields whenever they go too high. And we saw that in the US earlier this year.

Erik: Let’s move on to commodities. A lot of people, who are the same people that are saying inflation is on the rise, are projecting a really big move up in commodities. Oil has certainly moved higher. I think a lot of that is geopolitical. Base metals have moved up a bit. But, across the board, I don’t see massive changes.

What do you think in terms of the commodity outlook?

Mark: Well, when we last spoke in January, I said to you that one of the things that I really got wrong at the end of last year was that the move in oil was sustainable. That it could climb higher. And I’d been someone who thought that oil would never sustainably climb much higher again.

So, having got that wrong, I’ve avoided having too strong a view on oil in 2018 so far. But, looking at it, it does look like oil is quite comfortable up here. Obviously, there is very large speculative long positioning.

But the fact is they’re getting paid for that position. The backwardation in the curve is massive, so there’s a carry from holding that view. And I think it does look like oil can stay up here for a while. At some point, I do think that supply will pick up. We’re seeing the US rig count pick up, and that might see oil come off a certain extent.

But, overall, the commodities outlook looks slightly brighter than I probably thought a couple of months ago. And that’s why, perhaps, the yield range is maybe slightly higher than I was thinking. Because that might justify why we’ve got a spike up that goes a little bit farther than I was thinking.

But, overall, my commodities view hasn’t changed too much. I’m still constructive on metals. And that’s because I think the global growth story is still good. And, as I said back in January, because I’m not close enough to the metals market I refrain from any short-term tactical view.

But I’m overall constructive.

Oil — I’m kind of staying away from having a view, having gotten it wrong, but it does look like it’s comfortable enough up here.

And I think food prices was one of these big stories. And another thing for why inflation will tend to keep on disappointing over the long term, is that food prices still have probably more downside in the multi-year spectrum in terms of just much more efficiencies coming through in the food sector.

But, that said, short-term, they look like they definitely bottomed out in January and there’s probably a little bit more upside in the rest of 2018.

Erik: We talked about China last time. Chinese equities have moved lower and the momentum is still to the downside. What do you see for the Chinese currency, Chinese equities, and also the debt overhang that exists in China? A lot of people of course have predicted that eventually the unwind of China’s credit excess is going to be ugly.

Mark: Yeah, I’m still constructive in the Chinese yuan — I’ve always been very positive on the Chinese yuan in the last year or so. And I still think it’s a good story. I think, ultimately, it’s a currency backed by strong growth. It’s backed by a decent high yield. It tends to be a very low-volatility currency.

So, overall, I think the story is still good to the yuan. And I think it will continue to be managed in a way that makes it appealing whenever those high yields are there, in some ways to nearly be a carry currency in one way. And nearly a safe haven as well. So I think the yuan is good.

Chinese equities, as you mentioned, the momentum is still very negative. It’s looking really, really terrible in the short term. It does worry me a bit, the dynamic that’s going on there.

Is there something I’m missing? Is there suddenly a signal on Chinese growth that maybe we’re overlooking? Certainly it worries me, as someone who went through the GFC and remembers that in 2007 it was Chinese equities that collapsed much before everything else and sent a signal that there was something going on.

I am wary of the negative momentum in Chinese equities. That said, valuations just seem incredibly low. Generally forward-looking P/E metrics across most of the major indices in China are looking below 12. It’s looking really positive.

And, as I said, growth is very good. I think the government is handling the deleveraging process very smoothly. Maybe not as quickly as some people want, but certainly very smoothly. So I think the story is very good there.

And, finally, you mentioned the debt problem. And, as I said to you in January, this is not something that concerns me in the short term. Yes, there is a very, very large corporate debt bubble. Yes, it is still growing. Yes, it bears a long-term risk.

But it’s only one part of the equation. And the whole part of the equation is very, very positive in China. China Inc. is very wealthy. China has the ability to deal with this problem. It doesn’t mean that if this problem blows up there won’t be financial market disruption.

But I think the people who get way too beared up on China are just focused too narrowly on just one facet of the equation, and that’s the Chinese corporate debt bubble.

But they’re ignoring the fact that the Chinese government is wealthy, the Chinese government is enacting some very clever reforms slowly at the margin. And also we have the fact that the private sector is doing very well and has a high savings rate. And the banking sector is doing well. And there’s a lot of innovation in the companies there.

Erik: Let’s move over to Europe. We’ve had several guests comment that they think Mario Draghi may be about to run out of bullets. What do you see on the horizon for Europe?

Mark: It’s kind of as we discussed back in January. Europe, I think, it’s a less exciting story. Euro was a great story to play last year, but it’s kind of run out. As expected, Italy proved to be a red herring in terms of the politics there have been a mess. But it hasn’t really mattered for the currency. And I just don’t think the Euro is where there’s an exciting story at the moment.

The one thing I’ll say though — it’s not all of Europe — Eastern Europe is becoming more interesting again. We’re starting to see faster growth in some of the Eastern European countries. They have some problems in the short term, especially with some of the tensions around Russia and how that might spill over. And Turkey, of course, has some real geopolitical issues.

You’re seeing countries, including Turkey, Poland, Romania, they’re seeing growth over 4%. And I think Eastern Europe is becoming more interesting again. Because it’s been kind of left over, forgotten.

But, overall, Europe to me is a less interesting play at the moment than either US or Asia.

Erik: Let’s move on to emerging markets. The MSCI emerging markets index is about 4% weaker than last time we spoke. What do you see on the horizon for emerging markets?

Mark: It’s very much in line with my broader equity views that I mentioned, in terms of my broader global outlook. I expect some more bounce out of the months ahead. And EM quite often can be higher beta (volitility).

And there’s probably a lot of reason to think that, particularly some countries in the EM, really need a bit more of a correction. For example, Indian equities are still expensive.

But, overall, I am really, really super-bullish EM still longer term. I think that’s where the real long-term juice is. And I don’t know when we can return to tame the bullish theme for structural longer-term bull market, which I expect to happen in the second half of this year.

And I also still think that Asia is at the center of that fundamentally, structurally. It’s where the growth is. It’s where the demographics are. It’s where some of the reform is happening. It’s where some of the exciting things are happening on the corporate side. It’s a lot of the times the valuations are very attractive, as you mentioned, in China.

But Hong Kong, there’s a lot of Asian valuations are still exceptionally attractive. There are some countries that are a little bit overpriced still, and India is probably one of the best examples there. But it’s got such a good macro story longer term.

So I think there’s a lot of event risk about the China/Hong Kong story, which is maybe why valuations are low. The Hong Kong peg is certainly one thing that’s causing concern at the moment — and, of course, the whole deleveraging reform in China. It does make people worry about some financial market disruption.

But, overall, the EM story is just exceptionally positive longer term. And Asia is very much at the forefront of that.

Erik: Finally, let’s come back to the United States. You’ve already described your views on the equity market. But let’s tie it back to the US economic story.

What do you see on the horizon for growth and inflation? And how does that relate to markets?

Mark: US growth is good. I think we’ve probably seen the peak in terms of acceleration. I don’t think it’s going to run away. But I think it’s solid. I think we’re looking at heading towards about 2.8% growth this year. And I think inflation seems to be — I think consensus forecasts are verging around 2.5%.

I don’t see that inflation is going to accelerate to the top floor. I’m not someone who is worried about that, which is why I’m not someone who is a long-term bond bear. I do think that we continue to see that, for a number of reasons, wage growth is not feeding through to the CPI basket. And, therefore, we’re not getting that inflation pickup.

So I think that inflation probably is roughly stable around here, just a bit above 2% we’ve seen this year, which I think that the Fed will be very happy with. And I think, overall, it looks good. It goes to their arbitrary target. And, I think, growth about 2.8% looks a little bit disappointing, but I’m not sure we’re going to have the positive surprises come through.

We did get the tax deal come through Trump last year. And that has provided a boost, mainly to corporate earnings. But it will feed through the economy as well. And we’re seeing a little bit of a sign of that.

But I’m not sure we’re going to get much more, even if we get this big commodity infrastructure plan. The numbers that have been talked about in the past, $1 trillion over a decade, really isn’t that much. And it is much less than the US needs in terms of overhauling its infrastructure.

So the US growth story is perfectly solid. I don’t think the word “near recession,” I don’t think the end of the cycle is near, and that’s why I think it’s going to be generally supportive for equity markets.

I just don’t think there’s going to be an exciting acceleration. And therefore, the juiciest part of the bull market trade for the last 8 years has been done. But there is still some more upside.