Over the past week, as U.S. equities careened lower on the heels of a Fed hike, Jerome Powell’s latest bungled effort to force his “plain English” on the investing public, Steve Mnuchin’s Hank Paulson impression and, of course, Donald Trump’s decision to hold the government hostage in lieu of $5 billion in ransom money earmarked for the construction of a “steel slat barrier fence” (with spikes on top), we’ve been keen to point out that there was at least one analyst who suggested that 2,400 on the S&P was a possibility.
That analyst: Deutsche Bank’s Aleksandar Kocic, who you can be absolutely sure is busy writing and/or thinking about something more interesting than you are at any given moment.
For regular readers, Kocic needs no introduction and because our audience has become decidedly more “sticky” of late, we’re going to assume that most readers can safely be classified as “regulars”. But, for anyone who is new, just note that Kocic is incomparable. We’re not trying to establish an analyst hierarchy here. Rather, what we mean is that he often seems to be playing an entirely different game than everyone else to the point of creating what might very fairly be characterized as his own lexicon which he uses to construct unique frameworks built in part on references to myriad disciplines outside of finance.
Starting in February, Kocic began to expound upon the mechanics of the Fed’s efforts to restrike its put and his discussions of this dynamic have generally revolved around a characterization of the Fed as a convexity manager. Again, we won’t delve back into this in too much detail here because you can read to your heart’s content in the posts linked below.
The bottom line is that as part of his assessment of the Fed’s transition from convexity supplier to convexity manager during the course of re-emancipating markets, Kocic implored folks to think about the restriking of the “Fed put” as the normalization of equities’ beta to the short rate.
“February was the first time Fed restruck its put [and] October is its second restriking,” he wrote in October, noting that for most of the current hiking cycle, the high beta of equities represented “monetary policy [that] was protective of risk” or, said differently, the “Fed put post-2014 had been struck very close to ATM.”
A reversion to how things “used to be in previous cycles” (i.e., when the beta was ~10), would translate to SPX 2,300-2,400, Kocic has long contended.
Well, in case you haven’t noticed, we’re there – right in the neighborhood of SPX 2,400. The only question (for us anyway) was whether Kocic had noticed, and as it turns out he has – or at least according to a client note making the rounds on Thursday.
“Although the equities whipsaw continues around the Fed put, the strike around 2,300 as we predicted in February and reiterated in October seems to be doing all right”, he writes, in characteristically understated fashion, before reiterating how exactly it was that he managed to peg 2,300-2,400 on the S&P. To wit, from Kocic’s Thursday note:
A super accommodative Fed in the current cycle, had much higher beta, about 30 — a 1% rise in rates was commensurate with a 30% increase in S&P. This was synonymous with the strike of the Fed put close to ATM. As the Fed restruck its put, equities lost some of their appeal and their behavior is commensurate with lower put strikes (higher deductible). When translated to the language of beta’s, we get the following pic.
Yes, yes we do “get the following pic” which is of course an updated version of the pic Kocic has been using for quite a while to implicitly suggest an SPX target that would have seemed wildly far-fetched (to the bearish side) previously, but which, as of this week, looks mind-bogglingly prescient, especially considering the analytical process that went into deriving it.
“Each successive correction in equities is alignment with lower beta on its way to what is perceived as a ‘normal’ beta = 10”, Kocic goes on to flatly state, adding that “we are almost there.”
He adds some additional color on the selloff in credit (he doesn’t think there’s an outright “unwind” going on there) and he also reiterates his contention that “the market is misreading the outdated and unreliable signals and making incorrect conclusions about the economy, and using that information to scale down on risk.”
The overarching message from all of the above, is that while everyone on the planet is at least a little bit shocked at where the S&P is sitting right now, it’s perfectly logical to Aleks, and, as noted previously, the most amusing thing about the call is that it didn’t emanate from some kind of bombastically bearish take (indeed, he doesn’t seem to be buying the “imminent recession” narrative) or even from a dour assessment of what Fed policy normalization will entail for risk assets.
Rather, it just “is what it is” for Kocic, and “what it is” is a natural consequence of the re-emancipation of markets and the recycling of convexity as outlined in his various missives throughout the year.