Having correctly predicted the post-October market rout, over the past month Nomura's cross-asset strategist Charlie McElligott was more recently calling for what one could call an imminent bear market rally. And in the two weeks since Christmas, he got just that, writing in a note this morning that "this is the exact tactical rally I’ve been anticipating on a run back towards 2600+."
To be sure, as noted over the weekend, there have been numerous reason for why the animal spirits should - at long last - break out, with McElligott listing 4 specific ones including:
- Dovish Fed near-term capitulation (STIRs implying no further hikes / partial 2019 cut, while most-importantly, Powell stated a willingness to alter the balance-sheet run-off—although I’d note that this remains only a “break glass” option for the Fed)
- Incremental PBoC easing / stimulus (Friday’s RRR cut immediately following Premier Li Kequiang’s call on the need to increase counter-cyclical policy, including tax-cuts, additional RRR cuts and supporting SME financing)
- “Positive” China / US Trade “leakage” (today’s news that Vice Premiere Liu He unexpectedly attended the first day of trade discussions between the two countries, Kudlow’s Friday assessment that preliminary discussions were “a little more optimistic than usual,” as well as the SCMP report that Trump and Vice President Wang Qishan may meet at the World Economic Forum in Davos later this month)
- All against widespread broad-scale “under-positioning” in US Equities (US Equity Funds seeing -$196B of “Active” outflows over the past 1m; GS and MS PB data showing HF “net-“ and “gross” exposures at / near multi-year lows; Nomura CTA Trend data highlighting “Max Short” positioning in US Equities futures; HFR Equities HF Index 20d rolling beta to SPX at lows since May)
That said, Friday's ramp, which McElligott dubs a "very-FOMO scramble" was mostly catalyzed by Fed Chair Powell’s modest “about-face” from two weeks ago, "obviously boosted by relief from monster Jobs / AHE prints)" with the result being funds "renting" longs for a quick and easy trade. A few more comments from the Nomura strategist on Powell's dramatic Friday U-turn:
- Powell has once-again “bent the knee” to market vigilantes in regards to removing the “Fed policy error” left-tail concern and addressing “downside risk” fears (“…listening sensitively to the message markets are sending”);
- In-turn, he confirmed a “Fed pause” (“…with the muted inflation readings that we’ve seen, we will be patient as we watch to see how the economy evolves”);
- And most-importantly, he capitulated to market forces on “Quantitative Tightening” by voicing ability to alter course of the BS run-off (“If we ever came to the conclusion that any aspect of our plans was somehow interfering with our attainment of our statutory goals, we wouldn’t hesitate to change it, and that would include the balance sheet”)
It was therefore to be expected that the market's knee-jerk to Powell’s comments were a powerful “easing” impulse of what had been the most “restrictive” US financial conditions seen in years, with his message simultaneously
- sending USD lower
- relaxing US “real yields”
- driving Equities volatility sharply lower and
- tightening credit spreads dramatically
Even so, McElligott concedes that despite Friday's furious rally, the longer-term outlook for US Equities remains bearish, and is dictated by the 1) late-cycle nature of both the US- and global- economy, 2) the lagging effects of prior tightening / ongoing US balance-sheet runoff and 3) still-fading inflation expectations—all of which are “negatives” for stocks according to Nomura.
This is why the environment will continue to see these sharp tactical “under-positioning” rallies in Equities where risk is “grabbed”—but also then too a willingness to fade / de-risk into those rallies and shift to an “up in quality” / more defensive posture as US growth converges lower in late-cycle fashion, and towards the struggling rest of world economy.
In short, enjoy the bear market rally while it lasts, but once the market starts questioning whether the Fed and other central banks are "dangerously" out of ammo to prevent the next recession, as the IMF warned over the weekend, all bets are off.