Rally skeptics abound as the second half of what already counts as another extraordinary year for markets, macro and geopolitics dawns.
Among them is JPMorgan’s Marko Kolanovic, who it’s still fair to call the most recognizable name on the sell-side.
Kolanovic turned cautious late last summer, when it became apparent that central banks were willing to risk recessions to quash inflation. Although a handful of ardent Fed critics will insist on describing Jerome Powell as weak-willed no matter what he does, his actions over the past 15 months plainly suggest he’s concerned about his epitaph. Powell doesn’t want this: “Here lies Jay. He never found ‘sufficiently restrictive.'”
But it wasn’t just hawkish central banks that concerned Kolanovic. He was worried about geopolitics too, and the prospect of additional escalations both in eastern Europe and in the bilateral relationship between the world’s two superpowers.
Certainly, Marko was right about central banks and geopolitics. Markets have seen dozens upon dozens of additional rate hikes over the last nine months, and too many geopolitical escalations to count. The hikes aren’t over, and neither is the war (or wars, plural, if you count the US-China cold war and the innumerable simmering conflicts that claim lives all around the world every day without making headlines).
Stocks will be stocks, though, which is to say equities can become completely disconnected from “reality,” subject as they are to the vagaries of human emotions and the wholly unemotional influence of systematic strategies which, by virtue of being mechanical, have no conception of the extent to which they often chase their own tails, dialing exposure up and down based on momentum and volatility trends of their own making.
Throw in an exciting narrative (in 2023 it’s A.I.) and yawning gaps can open up between stock prices and the fundamentals they’re supposed to reflect. That’s where we are now, according to some of the Street’s more bearish strategists: With a wide disparity between equities and the fundamentals. It doesn’t help that 2023’s surge is among the narrowest rallies in recorded history, at least on some metrics.
If you ask Kolanovic, the disconnect (assuming you see one), is more likely to correct with cap-weighted equity benchmarks falling than via any of the more benign outcomes that might help close the gap between a challenging macro-policy conjuncture and an S&P 500 trading on a forward multiple that ranks 88%ile on a 50-year lookback.
“Some argue the next leg up for the market will be supported by laggards leading in H2 [but] we see this as a tall order given that underperformers are generally more cyclical with lower pricing power and higher interest rate sensitivity,” analysts led by Kolanovic wrote, in their mid-year outlook. “Absent preemptive Fed easing, we expect a more challenging macro backdrop for stocks in H2 with softening consumer trends at a time when equities have re-rated sharply.”
The S&P is trading at 18x even on an “ex-A.I.” basis, they noted, before warning that the “unattractive risk-reward for equities” looks particularly perilous in the context of “increasing investor complacency” and central bank balance sheets which are contracting again.
More than a few equities teams have articulated various iterations of a liquidity bear case for Q3, most of which center on the TGA rebuild (i.e., Treasury issuance post-debt ceiling). In addition to uncertainty around how much Treasury bill supply will be absorbed by cash exiting the Fed’s RRP facility (the more the better, as that would limit reserve drain), some bear cases also incorporate a lackluster global liquidity impulse in one form or another.
And then there’s the consumer, who may finally run out of excess cash in the US. I realize market participants are desensitized to that warning by now, having heard it time and again for well over a year. But consider that the resumption of student loan payments is a de facto liquidity withdrawal. JPMorgan estimates that headwind at $10 billion per month.
“The accumulated excess savings will likely be exhausted by October,” the bank said. On their count, there’s around $500 billion remaining. The high was $2.2 trillion. “Consumers are starting to show signs of weakness [and] fiscal tailwinds are fading with student loan repayment expected to restart this September,” Kolanovic and co. wrote.
Nobody knows quite what to expect when the cash pile illustrated by the grey bars in the visual above runs dry. Some have suggested a “Wile E. Coyote” moment for spending.
In that context, it’s worth noting that credit card rates are the highest in recent history. And Americans have a lot of aggregate credit card debt, even as household balance sheets are still generally healthy thanks in no small part to the very same pandemic wealth effect in property values and equity prices which many blame for driving up inflation.
“Even though broader labor and energy market trends remain favorable for now, consumers are increasingly relying on credit, pulling back on discretionary spending, substituting with cheaper options, trading down to private labels and downsizing home projects from remodeling to DIY repairs,” JPMorgan wrote, of consumer trends in the US.
As for sentiment, Kolanovic suggested under-positioning is no longer a viable contrarian bull case. “Equity positioning has significantly risen from last fall to now above average, as investors are chasing and there is growing recession fatigue,” he said. I made similar points late last week in “Did Bulls Just Lose Their Best Friend?”
Around 10 pages into what, in all, was a 47-page cross-asset strategy review, JPMorgan summed up their cautious stance on equities using just a few words: “In short, the risk of another unknown unknown appears high.” Indeed it does. In fact, we saw one over the weekend.
If you’re commenting on the strange events in Russia between Putin and the Wagner group….The Russians need to end this war soon if Putin is to remain in power. Ergo they need some sort of major victory over the Ukrainians. Their best fighters have been shown to be the Wagner mercenaries. The Ukrainians are building a new offensive in the Donbas. What to do? Have the Belarusians attack on the Northern border. The problem? They are an unknown entity as serious fighters. The solution – Move the Wagner group into Belarus to lead their troops without tipping their hand. After this weekend problem solved. Staged angry Wagner chief and Putin dispute somehow settled amicably with little if any bloodshed or consequences. Wagner group in Belarus. Who’d a’thunk it. Did they fool anyone? I guess we’ll find out shortly.
The exact same thing crossed my mind.
1) Prigozhin isn’t a military imbecile, he had to know he’d never beat the russian war machine with just 25,000 troops.
2) The Kremlin (and more to the point, the Russian propaganda machine) made a few perfunctory noises, but were remarkably laid back about this whole thing.
3) Lukashenko doesn’t do anything without Putin’s permission.
4) The deal was negotiated with remarkable alacrity and amity.
Now Wagner heads to Belarus. What next? My (completely wild) guess is they make a show of saying they’ll redeploy to various overseas Wagner missions in Africa, maybe even make a big deal out of loading up a few transport ships, and then it’s, Surprise, so nice to see you again Ukraine!
All that said, I have a hard time imagining they can actually take anyone by surprise.
If the Russians really have a supposed five million man standing army, why have they hired Wagner? Why the aborted attempt to press gang 100,000 new (untrained) troops some time back? Old equipment and older unhappy, probably mostly unpaid, troops does not a huge dangerous army make. Now they need to throw in Belarus? Same question, why? What’s really wrong?
Well they fooled the western media who is reporting that the Wagner group will be disbanded. I doubted it (the disbanding) the moment I heard it. You’re right, it is the right pretext/cover story to embed the Wagner group to start to train the Belarusian army. That said, western (especially US) intelligence has been all over the Ukraine war since before Putin invaded. I doubt they are fooling anyone who actually matters when it comes to intelligence, military tactics and decision making.
Also, bitcoin telegraphed the event starting Tuesday, not that the majority of people knew it at the time (including me). BTC price action was anomalous in relation to all recent drivers (USD, US interest rates, global equities etc). Then 3 days later… geopolitical “event” (or charade depending on one’s take).
I really enjoy and learn from the commentary here. But i think lots of folks are assuming putin has way more smarts than he actually has. Maybe once he did. But like an aging prize fighter he used to be good. Now he is far too isolated from real events to be effective. If he did manipulate a fake uprising it was a big error. I kind of doubt it. His ship is sinking…
Back on topic 🙂
I’m thinking the Wile E Coyote moment for spending has probably happened or is happening presently, though we won’t “know” it for a bit as data usually lags. There is a large portion of those cash balances in the chart from people retiring and cashing out on their homes. Those funds are not likely to be available to maintain current consumption nor are they available to be pulled into equities. Risk averse retirees with an assumed 30+ years of life left to fund are likely to stay in cash and collect 5%.
I would caution you to not put too much faith in a hypothesis that you cannot possibly know is correct or not. I can come up with other unprovable guesses where the cash pile came and will continue to come from.
I still believe we’ll have to wait until the end of summer for a major correction or a return of the Bear, seems like the perfect confluence of bearish events: student debt payments return, “excess” savings running out, the lag effects of hikes in full swing, higher for longer a settled reality and seasonality, plus whatever surprise Putin or Xi (or Biden) might share with the world. If we don’t see real price weakness return by then the coast is likely clear for the rest of 2023.