Last year, when we published our 2018 equity outlook with a cute baby bear on the front page and an S&P 500 target for end-2018 of 2,500, many investors told us that we were well below the Street’s expectations. Since the publication of our 2019 equity outlook, some investors have told us that being bearish is now consensual.
That excerpt is from a SocGen note out late last month that found the bank dispensing with the fake news (sorry) that being bearish was suddenly en vogue amid the ongoing selloff in risk assets and concurrent spike in volatility.
You might recall that SocGen’s year-end SPX target for 2019 is 2,400 and in the note mentioned above, the bank cites the familiar Bloomberg table that summarizes other banks’ year-end forecasts. The latest version (or at least the latest version I can pull up) is shown below.
“Among the 19 banks in the table, the median estimate stands at 3,079,” SocGen observed, before driving the point home by noting that “none of the 19 banks in the survey is looking for downside next year.”
Fast forward a couple of weeks and analysts are starting to rethink things. Wells Fargo’s Chris Harvey, for instance, is no longer sticking with the 3,079 target noted in the table. As regular readers are aware, Chris slashed his forecast weeks ago all the way down to 2,665.
Well, on Monday, Barclays’ Maneesh Deshpande cut his target as well. As you can see in the table above, Deshpande’s forecast was for SPX 3,000 at year-end and in a new note, he trims that to 2,750.
“The reduction of 2019 S&P 500 target is driven by a combination of a drop in EPS projection and earnings multiple”, he writes, adding that while Barclays’ top-down EPS model projection remains unchanged, the bank’s bottom-up EPS model forecast “based on bottom-up consensus forecasts adjusted for the stage of the cycle has declined substantially” as has their “fair value target for the P/E multiple driven by the drop in headline inflation and inflation volatility.”
The bank’s revised 2,750 target calls for EPS of $171 (down from $176) and a projected multiple of 16X (trimmed from 17X).
More interesting than the price target cut (you can probably expect more of those from Wall Street, especially if we get more guide downs like those from Apple and FedEx), is Deshpande’s discussion of what went wrong in December.
We’ve obviously spent a ton of time documenting the confluence of factors that made last month such an abysmal ride for investors and while Deshpande’s take is broadly in line with our own and that of other analysts who have weighed in, it’s worth highlighting a few passages and visuals from his Monday note.
“The last holiday season was one of the most volatile Decembers in recent history”, he begins, adding that if you ask Barclays, “this volatility was driven by a combination of ‘real’ headlines whose effect was exaggerated by poor liquidity and retail mutual fund outflows.”
The following chart is great. As the header suggests, it documents key headlines that led to volatility, with the light blue bars representing the range of the % move from the prior close and the dot representing the close.
That rather poignant illustration underscores the extent to which news flow was part and parcel of why December turned into such a harrowing ride, and as JPMorgan’s Marko Kolanovic has variously lamented, the way in which that news flow was disseminated helped stoke confusion and manic trading.
The headline hockey helped catalyze outflows from mutual funds (to the apparent benefit of ETFs) and also deep-sixed retail investor sentiment. “Figure 4 shows that the mutual fund flows were significantly negative during December after being relatively benign during the fall when the current selloff started”, Deshpande writes, describing the chart below which plots estimates of weekly flows from EPFR and ICI.
He goes on to flag Google trend data for interest in the following search terms: “Fed hike”, “Trade War” and “Recession”.
Tellingly, interest in “Fed hike” was far more pronounced in December than it was for the previous eight rate hikes. I’ll give you one guess as to why that is (spoiler alert: it’s because Donald Trump brought it to the public’s attention and whipped everyone into a frenzy, likely exacerbating the market reaction to the December Fed meeting).
That underscores two important points we’ve made on any number of occasions. First, Trump’s public attacks on the Fed had the opposite of their intended effect. They made the FOMC overzealous about defending their independence by moving ahead with a December hike and they also likely exacerbated the post-Fed selloff by spreading fear about the ramifications of tighter policy. On the spike in recession concerns (as evidenced by the chart in the right pane), that is a function of the self-fulfilling prophecy and various fearmongering we bemoaned in “Fata Morgana: Financial Parallax And Recession As Subverted Perspective” and “Fear And The Market’s Perverse Fascination With Calamity”, respectively.
All of the above was set against a backdrop of a hamstrung fundamental/ discretionary crowd still stinging from the October drawdown. “Although retail fund outflows only picked in December, outflows from hedge funds (especially for macro funds) were quite significant during October and November [and while] the numbers for December are not available yet, a continuation of the trend over the past few months might explain the volatility in asset markets”, Deshpande continues.
Next, Barclays turns to liquidity. When outflows and an incessant barrage of unpredictable headlines blasted out (and in some cases distorted) by social media and bloggers, collides with a lack of market depth, the stage is set for the kind of price action and wild swings we witnessed last month. This is yet another topic we’ve covered ad nauseam in these pages.
For his part, Deshpande flags the usual Emini market depth chart, before going a bit further in his efforts to analyze what’s going on. After noting that market depth is inversely correlated to volatility (a self-evident conclusion) he also observes that it depends on the level of the S&P. Specifically, he points out the secular decline of liquidity since 2010 and after running a regression, proceeds to explain things as follows:
While the dependence on the level of volatility is intuitive, how do we understand the dependence on the level of SPX? This qualitative relationship can be roughly deduced if we assume that, over this time, the market makers’ risk capital has stayed constant. Thus, say if a market maker is willing to carry an overnight position with a risk of say $100. The corresponding notional is then $100/VIX. Hence the overnight position in terms of the number of contracts would be $100/(VIX*SPX). However, this is the total position which he would not offer in one shot. This total position would be spread out across the order book and the range of prices would itself be proportional to VIX*SPX since that is how much the prices can move intra-day. Hence the size offered at any given price would roughly be 1(VIX^2*SPX^2). Thus, a market maker’s risk capital defined as MM Risk Capital proxy ~ Emini Contract Size * Volatility ^2 * SPX^2 should roughly stay constant. Figure 10 plots this measure along with the residual from the above regression and we see that these two metrics have remained much more range bound relative to the raw bid-offer size.
Note that last bit: “… these two metrics have remained much more range bound relative to the raw bid-offer size”.
As you can see from the chart, that was true right up until December when they dove. “Even these adjusted measures of risk capital have declined,” Deshpande goes on to write, before delivering some hopeful-sounding musings about the longer-term ramifications of the above.
Ultimately, Deshpande’s analysis echoes the notion that multiple negative feedback loops were in play in December and while Barclays is sticking with the idea that a US recession is a low probability outcome in 2019, the bank i) flags a prospective global slowdown as a material risk to US equities, ii) warns that while the risk of a Fed policy mistake has fallen, it’s still “high” and iii) cautions that a “ceasefire” on trade is not the same thing as a “peace treaty.”
The overarching message from the above (and this is just us editorializing) is that all of those risks can conspire with lackluster liquidity (which, again, appears to be a fixture of markets, even on adjusted measures) and a highly efficient headline dissemination network (i.e., news outlets, blogs and especially social media) to create a perilous environment where market sentiment can run well out ahead of economic fundamentals.