It’s been a while – which is understandable because, well, because holidays and such – but Marko Kolanovic is back.
When last we heard from the Street’s most revered strategist, Kolanovic warned that the market was becoming increasingly disconnected from economic reality.
In the course of explaining that disconnect, he cited a number of factors, not the least of which was the rampant dissemination of misinformation, both market-related and otherwise. He also cited a dearth of liquidity, bombastic rhetoric from the Trump administration and higher rates to explain ongoing volatility.
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That was on December 7.
Needless to say, things deteriorated rapidly thereafter, with U.S. equities logging their worst December since the Great Depression and volatility surging amid thin liquidity, a U.S. government shutdown and no shortage of fearmongering from all corners.
In his latest note, out Thursday afternoon, Kolanovic kicks things off as follows:
Over the past month, the confidence of equity investors virtually collapsed. The month of December proved us wrong in the view that the market would rise into year-end and in 2018 overall.
After reminding everyone that his call for a decent end to 2018 was predicated on underexposure from both the fundamental/discretionary crowd and also systematic investors as well as steep de-rating amid the burgeoning selloff, seasonality, the ostensibly positive outcome of the G20 talks and the Fed’s apparent dovish relent (i.e., Powell walking back “long way from neutral on November 28), Marko calls it all “too little, too late.”
“Q4 turmoil appeared amid selling from systematic and discretionary hedge funds, the largest fund outflows since 2008, and an unprecedented collapse in market liquidity”, Kolanovic writes, before noting that the de-risking catalyzed by the October rout and tenuous stabilization in November seemed to set the stage for Powell and the G20 truce to “prod the market into a December rally.”
Alas, it was not to be. Kolanovic documents what came next as follows:
Instead, already fragile sentiment was undermined by political uncertainty from the US administration, the December FOMC meeting, a slowdown in economic data, and a viciously negative news and social media cycle. These developments brought a large amount of selling from mutual fund investors in an environment of poor liquidity.
We talked at length about the mutual fund selling on December 23 and Kolanovic illustrates it in the figure on the left below.
(JPMorgan)
“A complete disaster was averted by fixed-weight portfolio rebalances that were buying a significant amount of stocks during the last week of the year”, he goes on to write, describing the December 27 pension rebalancing flow stick save (right pane above).
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Clearly, all of this was exacerbated by lackluster liquidity, both on the downside (for most of the month) and on the upside (during the rebalancing flows).
Describing the charts above, Marko notes that “one can see that both retail outflows and pension inflows were among the largest in history (only 2008 and 1987 saw larger flows).”
Kolanovic goes on to suggest that retail flows can be a contrarian indicator as the retail crowd “tends to buy at times of exuberance and sell at times of panic.” He also notes that pension buying tends to have a decent track record. The insets on the charts above shed a bit of light on those contentions.
But Marko does acknowledge that at this juncture, we may have gotten ourselves into a self-fulfilling prophecy, something we’ve been warning about in these pages for at least two months. Here’s Kolanovic:
That said, we do recognize that the risk of a negative feedback loop (e.g., wealth effect of declining stock market) has increased meaningfully since December.
He also delivers his take on the role of systematic flows and algos in the recent market turmoil, but that deserves its own dedicated post. For now, we would also remind everyone that Marko made a number of prescient calls last year including the general warning that volatility and tail risks would rise, a series of bottom-calling successes (specifically, February 9 and May 1) and a correct call on the EM-DM convergence, although that convergence ended up being less “benign” in character than everyone hoped.
Wow, you were busy today. Love your reports, but your pace just boggles my mind. You give Trump’s tweets (volume wise, not wise wise) a run for their money. To wit: Happy New Year!!
Sometimes looking for a complicated explanation needs to be replaced by a simple one. Even for the best of us, if we step back a few paces and focus at a range where our eyes see clearest it can help see through the fog of confusion . We all saw this coming if we didn’t get too greedy … It was just a matter of when not so much why… The why was obvious.!!
Ahh finally thanks for the secondhand Gandalf fix. Seems he pounded the table about risk of a violent low-volatility unwind for a while before it came to pass also…
I love the “and such”.
Ok, his note suggests he is shell shocked. Not a lot of insight. Of course reflexivity is alive and well. The duration of the unease and any policy adjustments will help in declining the future course. Still a lot of overvalued stocks out there but for companies with moats a 10yr at 2.65 makes those future cash flows more appealing. And the equity risk prem in those is looking a whole lot better.
Gandalf sold out to Dimon’s world view. Dimon should fire him for not making an independent professional judgment. Amoa and all these “analysts” are using metrics from the 70s, which make them too late today. They maybe could look again about intrinsic concepts in Smoot Hawley.
You assume that anyone who isn’t bearish isn’t making an “independent, professional judgement”. Are fearmongering and generalized pessimism the determinants of “independent and professional” now? Give me a break. Look at the people who have been spouting that “fear”/”crash” bullshit on their blogs for 9 years. How did those predictions turn out? Spoiler alert: The authors became standing jokes in the financial community, although on the “bright” side, they got rich off clicks from the Alex Jones crowd.
Now, I am no theoretical physicist, but this sentence makes absolutely no sense to me: “Kolanovic goes on to suggest that retail flows can be a contrarian indicator as the retail crowd ‘tends to buy at times of exuberance and sell at times of panic.’” That…that seems to be the opposite of contrarian, no?
That is the point he was making. When retail is flushed out in a panic that could in most cases be a good buying opportunity. And heavy retail buying could be a good opportunity to lighten exposure to risk.
Key word is ‘indicator’. Trade counter to retail flows.
I just love it when the smartest guys in the room have to walk back the talk. I think we are in one of those times that what anyone gets ‘right’ will be mostly a residual accident. Until the turd-in-office is removed why would anyone act rationally other than to GET OUT of town? Since my colorful introduction to the macro compliments of and to Herr H., and subsequent interest, I am now fully qualified to say, macro shmacro…