So markets took it on the chin pretty good this past week, with a lot of pain focused on the NASDAQ.
But overall, markets are doing quite nicely, and remain quite close to their all-time highs. Unless you’re very heavily invested in the hottest parts of the market, you’re doing fine.
So what could trigger a real hard sell?
In a note to clients, Citi credit strategist Matt King describes what could spur a real “Wile E. Coyote” moment.
It goes like this:
But with credit investors likewise mostly long and uncomfortable, could what starts as a position correction turn into something much more serious? After all, it’s not just tech where valuations have become disconnected from fundamentals. As our US HY strategist put it after seeing numerous CLO investors this week, “Whatever the asset class, the pattern is the same. Investors are long risk, invested in assets that aren’t their usual holdings, and wondering who is buying their old paper.” Wherever we go, investors think their market is expensive — but are forced to buy it anyway.
This is not a new problem, either. Credit spreads stopped following corporate leverage almost two years ago. We don’t think it’s a coincidence that that’s almost exactly the same time equities stopped following analysts’ earnings revisions.. Even this week, Alcoa surprised positively — but only provided you looked at reported earnings, not GAAP ones, and ignored some extraordinary restructuring charges. That might seem reasonable enough until you consider our analyst’s remark that “in the ten years or so I have been following Alcoa results there has never been a quarter without ‘restructuring’ charges”. And of course we got a new Greek 5-year trading with a yield that € iBoxx had as recently as December 2011 — despite debt/GDP of 177%, higher than before its restructuring?
Try a bit harder, and you could paint a bleaker picture still, in which investors may be coming perilously close to realising that market levels owe everything to central bank stimulus and nothing to an improvement in underlying fundamentals. What if the much heralded “improvement in earnings to match the rerating in the market” fails to be delivered in coming weeks? How long till investors realise that extra stimulus in Japan might stem the Nikkei’s decline, but is unlikely to generate the economic recovery everyone is hoping for, no matter how large its size? And that the problem afflicting China — that the growth rates to which investors have become accustomed are utterly reliant on an unsustainable expansion of credit — is in fact a problem worldwide?
King might be overstating things a bit, at least in terms of this idea that there’s been no improvement in fundamentals. After all, just this week we got the best initial jobless claims reading since the U.S. economic crisis. And though it’s true that Greek debt is still staggeringly high, the Eurozone as a whole now has an implicit ECB guarantee (“whatever it takes”) that didn’t exist before the crisis existed.
But King is right, that to some extent asset markets have always reacted to the whims of central banks, and if the perception is that things are turning, then it’s anyone’s guess where the floor is.
That being said, King doesn’t think the music will stop any time soon. The BOJ isn’t done, the ECB likely has more to do, and the Fed continues to sound quite dovish. So, he says, we might be on borrowed time, but there’s likely more of that borrowed time to come. Yay.
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