JP Morgan:
Kolanovic explains how to hedge against this ongoing storm (“increased allocation to gold, cash and VIX”), with the section on gold particularly delightful for his crucifixion of the strawman created by the most famous Obama tax advisor and crony capitalist from Omaha:
The arguments against gold that we have heard were along two lines: The first is what can be loosely called “Warren Buffet’s” argument: “Gold is a relic of past; aliens visiting earth would be puzzled why people hold it at all.” As the argument is non-quantitative in nature, one can only address it as such. If indeed aliens could overcome space-time barriers, they would also know that the metal was used as a store of value longer than any other real asset. Since the beginning of written history, countless currencies and governments emerged and failed while gold kept approximately the same purchasing power (albeit with some volatility, and positive correlation to levels of risk).
All we can say here is that when JPM employees viciously attack Buffett for his position on gold, hold on tight.
Kolanovic also crushes Wall Street’s penguin momentum train:
The second argument was that of Momentum: “if an asset was going down, it will keep on going down,” We have concluded that many of our competitors rely on momentum in their commodity forecasts (e.g., when oil is $150, they forecast $200; when it is $30, they forecast teens). This type of trend following can always be rationalized (e.g., oil will go down because it is very difficult to store it – so it has to be sold; and Metals will go down because it is very easy to store them – so production will not slow down). While a simple momentum prescription does work most of the time, the key is to assess the likelihood of market turning points during which one can lose years of profits in a matter of days (less painful for a sell-side analyst and more for an investor).
More apropos to the current global bear market and economic slowdown, is Kolanovic’ warning that a recession as a result of the market’s loss of trillions in market cap now seems inevitable:
Global markets are now facing a significant ‘negative wealth effect’ that has a potential to result in a recession. This negative wealth effect of low commodity prices and a strong USD combined with the slowdown in China could be comparable to that of the 2008/2009 crisis (it involves diverse effects ranging from layoffs in the Global Energy sector to a lack of EM Sovereign wealth flowing into developed market equity hedge funds). While the economists were debating if the low-priced oil is good or bad for the economy, the equity markets never had any doubts – Oil and Equities were moving down together.
Finally, to our applause, Kolanovic concludes by slamming ole’ crony uncle Warren one final time (no point in wasting too much time on the senile billionaire).
Finally, we think the aliens from the previous section would likely be surprised: not with the gold price, but with markets and an economy that are driven by a handful of central bankers taking active market views.
The aliens would quickly understand, however, when they realize they are dealing with a banana planet in which the central bankers only serve a handful of billionaire oligarchs, while leaving billions of people to fend for themselves.
Kolanovic’s full note:
EQUITIES: Exposure of systematic strategies (CTA, Risk Parity, Vol Targeting) to equities is relative low, which reduces some downside tail risk for the S&P 500. Currently, the main risk comes from deterioration of sentiment and fundamental selling (hedge funds, pensions, wealth funds, retail, etc.). Deleveraging of Equity Long-Short hedge funds is an overhang as well, given the poor performance YTD (see, for example, HFRXEH index). Quant funds took a significant hit with the momentum sell-off during the first week of February (see HFRXEMN index) and may pare gross leverage. A market-neutral portfolio of Momentum stocks declined ~6% in the first week of February and has been recovering slightly over the last two days. Increased volatility, deleveraging, rotation out of momentum, and weak sentiment will continue to be a headwind for the S&P 500 in coming days.
GOLD: Since the end of last year, we have been advocating increased allocation to gold, cash and VIX. Specifically on gold, we have argued that it would benefit from the main market concern, which is the rising risk of a global recession, as well as potential mitigation of these risks: the Fed turning more dovish and a weaker dollar removing pressure from emerging markets and the commodities sector. In an unlikely tail scenario that we see as a temporary loss of confidence in central banks, gold would likely benefit as well. The arguments against gold that we have heard were along two lines: The first is what can be loosely called “Warren Buffet’s” argument: “Gold is a relic of past; aliens visiting earth would be puzzled why people hold it at all.” As the argument is non-quantitative in nature, one can only address it as such. If indeed aliens could overcome space-time barriers, they would also know that the metal was used as a store of value longer than any other real asset. Since the beginning of written history, countless currencies and governments emerged and failed while gold kept approximately the same purchasing power (albeit with some volatility, and positive correlation to levels of risk).
The second argument was that of Momentum: “if an asset was going down, it will keep on going down,” We have concluded that many of our competitors rely on momentum in their commodity forecasts (e.g., when oil is $150, they forecast $200; when it is $30, they forecast teens). This type of trend following can always be rationalized (e.g., oil will go down because it is very difficult to store it – so it has to be sold; and Metals will go down because it is very easy to store them – so production will not slow down). While a simple momentum prescription does work most of the time, the key is to assess the likelihood of market turning points during which one can lose years of profits in a matter of days (less painful for a sell-side analyst and more for an investor). We have written on market turning points from a theoretical perspective, as well as in the context of recent market moves, specifically in terms of positioning, gold CTA signal turning positive, etc. For a further rationale behind the gold thesis, see notes from our Metals strategist (here and here).
CENTRAL BANKS AND OIL: Central banks outside of the US have been trying to push on a string recently with negative rates. It has not produced desired results (e.g., a sell-off in the banking sector). Our view is that over the past 18 months, the Fed has been too concerned with the risk of inflation, and perhaps too little with global deflationary pressures and a crisis outside of the US. This has contributed to a rapid strengthening of the USD and put additional pressure on Emerging Markets and certain segments of the US economy.As a result global markets are now facing a significant ‘negative wealth effect’ that has a potential to result in a recession. This negative wealth effect of low commodity prices and a strong USD combined with the slowdown in China could be comparable to that of the 2008/2009 crisis (it involves diverse effects ranging from layoffs in the Global Energy sector to a lack of EM Sovereign wealth flowing into developed market equity hedge funds). While the economists were debating if the low-priced oil is good or bad for the economy, the equity markets never had any doubts – Oil and Equities were moving down together.
So, if the negative rates and more bond purchases are losing effectiveness, what else could central banks do at this point? Could they buy commodities (other than gold)? Should they urge for a fiscal stimulus (they are governments’ biggest bondholders)? Perhaps as a start, a hold could be placed on all planned rate hikes. Finally, we think the aliens from the previous section would likely be surprised: not with the gold price, but with markets and an economy that are driven by a handful of central bankers taking active market views (on inflation, oil, etc.). Last but not least, they may wonder how the current levels of oil production outside of the US make any economic sense.
