Late last month, Wells Fargo’s Chris Harvey delivered his “top 10 predictions for 2020”.
One of them has already come true.
“Political risk rises” is number five on Harvey’s list. Suffice to say geopolitical tensions escalated materially this week.
Harvey wasn’t necessarily talking about foreign policy risks, though. Rather, he was referring to US election risk, and specifically Tech, which he says may become “the new Healthcare during election season as it becomes one of the few bipartisan piñatas”.
He also cautions investors to expect a 5-10% pullback in the first half of the new year.
“With volatility low, credit spreads historically tight, the Fed liquefying markets, Phase One appearing to be done, and equities at all-time highs, the stage seems to be set for a healthy stock correction in 1H20”, he says.
A technical “correction” (i.e., a selloff of 10%) would count as the largest drawdown since Q4 2018, when the longest bull market in history had a brush with death (see bottom pane in the visual above).
Harvey also sees volatility becoming more volatile “as a function of elevated expectations, optimistic sentiment, underappreciated political risk and a trade war that’s far from complete”. He notes that from 2017 to 2019, there were an average of 1-2 VIX spikes above 20, but in 2020, “more frequent spikes and higher highs in volatility” should “create trading opportunities”.
In addition, he says the Fed’s balance sheet may “emerge as the marginal driver of risk assets rather than trade and tariffs”.
Market participants are obviously watching closely to see how the Fed will proceed with organic balance sheet growth and the effort to rapidly return to an “abundant reserves” regime “with a buffer”. As we saw in September, policymakers proved inept at predicting when reserve scarcity would kick in.
Many believe the Fed will have no choice but to pivot to coupon purchases. Ultimately, all outstanding repos will likely need to be “converted” (if you will) and from there, the discussion around how to implement the long-rumored standing repo facility should be front and center. The December Fed minutes contained some discussion around those issues.
Among Harvey’s other predictions: The penalty for EPS misses “likely rises in 1H20”, election uncertainty “keeps a lid on speculation”, Phase Two of a China trade deal becomes “elusive” and, amusingly, “passive investment flows could contract for a quarter as investors realize that these funds could lose money”. Gasp!