Thursday, February 25, 2016

Goldman Expects A 20% Drop Before Markets Can Rally...........

Goldman Expects A 20% Drop Before Markets Can Rally

It's All A Short Squeeze.

Since last Thursday's intra-day low, the S&P rallied +6.6% in four days with the former laggards and most heavily shorted stocks leading the charge. This action is very typical of a bear market rally and should be viewed with skepticism.

For those wondering whether we'll be riding the short squeeze euphoria wave higher, Goldman's answer is definitively "no." In a note the bank says short covering and positioning have fueled the bounce and that a sustained rebound is exceptionally unlikely until either valuations get significantly more attractive.

On Monday, everyone was giddy that the rally was back on. Less than two days later, the dour fatalism of some HFT algo stop hunting price action and a few comments by the Saudi oil minister, and the markets have remembered that nothing has changed and that nothing has been fixed.

Indeed, the bullish euphoria that had gripped markets is all gone: "It will take some time before market sentiment does turn. It's still very pessimistic. Most investors are very risk averse.

The market has all of a sudden woken up to two very important and very interconnected facts: 

1) central banks are desperate, and 

2) sluggish global growth and trade look to have become structural and endemic rather than cyclical and transitory.

Oil is still a huge question mark and barring a Saudi production cut which oil minister al-Naimi made clear on Tuesday isn't going to happen will likely continue to fuel the global disinflationary impulse. Meanwhile, markets are asking more questions about negative rates and central banker omnipotence every day.

It is risky to read too much into price action currently. Volatility remains very high and many of the moves may reflect positioning rather than a genuine change of view about fundamentals. Remember that at the heart of the correction there has been a growing concern about growth and, with it, the risks of deflation.

Goldman's conclusion: there will be no sustained rally until at least one of the following three things occurs: 

1) Valuations become cheap; 

2) The broad macro data stabilizes enough to shift up inflation expectations and/or; 

3) Policy action becomes more supportive.

Put simply, number 2 isn't going to happen. At least not for the foreseeable future. Oil prices would need to rise dramatically, the global deflationary supply glut would need to moderate on the back of a sustained uptick in aggregate demand, and China would need to stop exporting deflation.

As for number 3, monetary policy can't get any more supportive. Literally. Rates are so low that the cash ban calls are rolling in and for a variety of reasons, policy makers across the globe have been reluctant to embark on massive fiscal stimulus programs.

Finally, as for number 1, either earnings would need to rise or else stocks need to fall. Considering the fact that the world looks very likely to careen into recession just as primary market appettite for the bond deals that are fueling bottom line-inflating buybacks dissipates, I know which alternative seems more likely to me.

So with the market wide short squeeze now officially over, global selling of stocks has resumed, dragging down everything from banks to commodity producers as well as emerging markets, while in the US S&P futures have tumbled back down to, or rather just below, the psychological support level of 1900 early Wednesday am, driven by another day of tumbling USDJPY, but also by the latest surge higher in gold - something which according to Goldman, has stopped out its gold "short" which clearly means systemic risk is once again rising.

March will not be a pretty month for risk assets...... 

There is still a great deal of bad energy debt hanging over the global markets, a potential currency devaluation in China, and a crisis brewing in European financials.

Are We Back In February 2008?

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