Well, guess what? Marko Kolanovic was right – again.
Back on May 1, as the world was focused squarely on trade tensions, the possibility of a Fed overshoot, domestic political turmoil in the U.S., burgeoning EM risks and all manner of other potentially destabilizing eventualities, Marko suggested the old “Sell in May” adage might be wrong in 2018. In fact, he said it might well be a better idea to “Buy in May.” To wit, from his May 1 note:
In this (so far, chaotic) year — we also witnessed significant US equity fund outflows during the period supposed to be the strongest seasonal part of the year. If the “upside down” market patterns continue, the “sell in May and go away” prescription (that reflects a reversion of inflows early in the year) may turn into “buy in May” this year.
Headlines (often tweets) dealt a blow to the confidence of US markets and businesses. While still a destabilizing factor, risks can be walked back by the administration or undone by new deals. On the other hand, positives such as tax reform will stay, and cannot be undone regardless of e.g. the outcome of mid-term elections and related political changes.
I took a closer look at that note and the extent to which it represented a fair and balanced assessment of the prevailing push and pull market dynamic in a piece for Dealbreaker called “You Mortals Weren’t Ready For JPMorgan’s Marko Kolanovic — And Marko Wasn’t Ready For You Mortals“.
In the May 1 piece, Kolanovic of course reiterated the risks inherent in modern market structure. That’s his wheelhouse and those concerns are still present. But he also stuck with his previous call that eventually, the systematic crowd would begin to re-risk after the forced selling that accompanied the February VIX-related turmoil that triggered something on the order of $200-250 billion in offloaded equities exposure by CTAs and risk parity.
Well fast forward to June and guess what? Last month was the best May for U.S. equities since 2009:
On Wednesday, Kolanovic’s latest is out and he begins by noting that in the two weeks following his May 1 note, “the market rallied ~5% on virtually no positive news [and] given that the average historical return for the month of May was -0.3%, the seasonality trend was clearly broken this year.”
With the VIX back at an 11 handle and volatility seemingly on the back foot (Italy notwithstanding), Marko suggests that more re-risking is likely in the cards. Here, in brief, is the bull case according to Kolanovic:
Our view is that the re-risking is likely to continue during the summer as volatility stays contained and investors increase equity positions. Volatility is likely to be contained due to summer seasonality, dealers’ long convexity positions, and lower correlations after a large spike in Q1. Investors’ exposure to equities is still relatively low. Systematic strategies de-risked on account of the high realized volatility in Q1 and discretionary investors de-risked on account of various macro fear narratives (including inflation, 10Y >3%, trade war with China, Syria/Iran, Emerging Markets, PMI slowdown, Italy, dollar, quantitative tightening, etc.) and, despite the recent rally, have not meaningfully re-risked.
There you go – the re-risking has further to run. And look, you don’t have to buy into that (figuratively or literally) if you don’t want to, but the fact is, Marko was right to suggest investors buy the dip after the February unwind and he was right to suggest May would break with historical precedent.
Further, don’t forget that buybacks serve as something of a real-life “plunge protection” bid (no conspiracy theories about a retired Janet Yellen trading ES from her living room necessary) for stocks and are expected to clock in at between $650 billion and $850 billion for 2018, depending on whose estimates you’re inclined to accept.
Ok, next Marko revisits his thesis from March that Donald Trump simply cannot afford to start an all-out global trade war. You might recall that Kolanovic took a game theoretic approach to this. To wit, from a March note:
First let’s look at the risk of a trade war that would be disruptive to US equities. Our analysis is inspired by game theory, and we simplify the problem to “two players,” two asymmetric outcomes, and a non-zero sum game. We project the complex web of political relationships to 2 players: 1) actual actions that could lead to/avoid trade war (that can in turn destabilize global equities), and 2) rhetoric (that can be used for political purposes). Our analysis suggests that there will be no trade war meaningful enough to destabilize equity markets. In fact, we already had the same setup and used the same approach with the ‘border adjustment tax’ last year (when many investors wasted resources analyzing an extremely unlikely outcome).
On Wednesday, he revisits that.
“Earlier in March we argued that the current administration cannot afford a disruptive trade war that would destabilize equity markets in an election year,” Marko writes, adding that “while we still think this is true, trade tensions continue to inflict damage to investor psychology and business confidence.”
He goes on to try and quantify how much market value has been lost since March from combative trade war policies. His conclusion: roughly $1.25 trillion.
Can that be recouped? Well, yes. And to explain why, he harkens back to his note from May and the observation that while fiscal stimulus and buybacks are facts of life, trade policy is fluid and at least some of the damage can be reversed. To wit:
Taking the current market capitalization, this translates into $1.25T of value destruction for US companies. For a comparison, this is about 2/3 of the value of total fiscal stimulus. The value destroyed by a trade war might be reversible if policies are reversed, while the positive impact of fiscal measures is likely to remain. This would likely catalyze a ~4% market rally. However, if this uncertainty hangs over the market for a more extended period of time, the damage becomes more permanent and the probability of a disruptive tail event increases.
Do note that this is entirely consistent with Trump’s penchant for seeing how far he can push things and then abruptly reversing course when something (be it negative press coverage or an adverse market reaction) causes him to reevaluate things.
This can of course work in the opposite direction as it has recently when he seemingly abandoned the trade truce struck by Mnuchin in favor of the more aggressive tactics advocated by Steve Bannon (in a Bloomberg interview) and Peter Navarro (who, after being temporarily sidelined following a shouting match with Mnuchin in Beijing, seems to have gained the upper hand again in the ongoing tug of war at 1600 Penn. between the isolationist factions and the moderates).
The trade debate ultimately comes back to one thing: the midterms. Trump needs to strike a tedious balance between convincing the base that he’s made good on his “tough on China” promises and not pushing things so far that equities sink, damaging his “market scorecard” (to quote Kolanovic one more time).
In any event, if you’re looking for a constructive outlook for your bullish leanings, then you now have one and what I would reiterate is that the latest note from Marko again offers a cogent, balanced assessment that’s mercifully devoid of the type of emotional/irrational psychology that tends to get traders and investors in trouble.
Marko is, however, assuming that Trump is some semblance of rational and intelligent…