Back on April 29, after delivering what was otherwise a relatively upbeat take on the outlook for equities, JPMorgan’s Marko Kolanovic cautioned that the resiliency of the US economy and the surge in both US and Chinese stocks off the December lows, potentially reduced the incentive for Washington and Beijing to rush into a trade truce.
“Strong numbers in China and the US market at all-time highs remove some of the urgency for both sides to sign a deal”, Kolanovic wrote, warning that “if there is an idiosyncratic event, systematic investors would… commence selling equities.”
In the course of listing examples of “idiosyncratic events” that could throw markets for a loop, Marko listed “Trump abruptly walking away from the deal.”
Although the US president is trying to spin the latest escalation in the trade conflict as an example of China “breaking the deal”, the reality of the situation is that whatever went on behind the scenes (i.e., irrespective of whether China did in fact undermine the talks by going back on an implicit agreement to change some Chinese laws), it’s undoubtedly the case that Trump could have opted for a less bombastic response. Even if you think it was necessary to threaten China with a tariff increase, there are better ways to go about that than announcing it on Twitter on a Sunday evening minutes before trading gets underway in Asia.
But Trump will be Trump and, again, he appears to believe he’s “playing with the house’s money” thanks to rally in US stocks in 2019. That then raises questions about his pain threshold or, put differently, one wonders where the strike price for the “Trump put” is. In a new note out Thursday, Marko Kolanovic has an answer.
“Observing actions of the US administration makes it apparent to us that the tone and sentiment towards the trade war changes with roughly ~100 points on the S&P 500”, he writes. “The market moving higher generally leads to a hardened stance and more confrontational tone, and the market moving lower generally leads to either verbal or actual progress towards trade resolution.”
This is “countercyclical protectionism”, as it were, and it comes against a backdrop where both fiscal and monetary policy have become procyclical. We talked about this at length in “Trading Trade And A ‘Spiral Away From Equilibrium’”. In that post, we highlighted the following visual from BofA:
The bank’s point was that you can use the standard framework for conceptualizing the relationship between markets and fiscal/monetary policy to evaluate countercyclical protectionism. “Weak markets motivate friendly policy and strong markets do the opposite”, BofA wrote.
Kolanovic on Thursday writes the “‘Trump put’… has now evolved into a ‘Trump collar’ (i.e. limited upside due to escalation of the trade conflict).” For Marko, the Trump put is 3-4% out of the money”, but the good news is, it “would kick in well before the ‘Fed put’, which is likely 10 – 15% out of the money.”
As far as how equity positioning changed last week, Kolanovic calls the adjustments “moderate.”
“An initial spike in volatility led to modest de-risking from volatility-driven investors [but] the selling was to some extent countered by increased buyback activity in the aftermath of the Q1 earnings season”, he writes, adding that “the quick pullback likely exposed the convex long exposure of funds, and on margin attracted fundamental buying.”
On CTAs, Marko says their beta to equities “marginally increased”, a development he calls “particularly interesting” and indicative of positioning “lagging historical 6-12M trend signals and potential implementation of short-term reversion signals.” Generally speaking, Kolanovic says systematic exposure is low (vol-targeting in 35th percentile, CTAs in the 40th percentile).
He also notes what we’ve discussed here at length over the past several days with regard to the monetization of long vol. trades helping to calm things down and otherwise prevent the vol. spike from accelerating and triggering the “liquidity-volatility-flows” loop. To wit, from Marko:
In the VIX complex, since May 5th investors have pulled over $300Mn from unlevered long VIX products, and over $450Mn from levered products (mainly UVXY). Unwinding of this exposure has kept in check the increase in the VIX and prevented the type of VIX increase we saw in February and October last year.
Ultimately, Kolanovic’s base case is still that the trade war with China is resolved at some point this year, but he describes his constructive outlook as “cautious”, which is a bit of a change in tone from recent notes. Of course that’s fine, because the S&P had already (basically) hit his year-end target by the time things went off the rails, so Marko was vindicated weeks before Trump threw another monkey wrench in the plan.
Specifically, the (probability-weighted) year-end SPX price target remains 3000. A trade deal could push things to 3200, while a “complete breakdown” could presage a fall to 2550 or another number “significantly below” 3000, Marko says.