Having been bearish for a good part of 2018, Bloomberg macro commentator and former Lehman trader, Mark Cudmore writes that even he was surprised at how fast his skepticism was validated and how rapidly things shifted over the past week: “even as someone who wrote on Monday last week that an Italian debt crisis would soon become the dominant theme for markets, I absolutely didn’t envision the speed of Tuesday’s meltdown. With that disclaimer, I still don’t see the reason for Asia’s traders to significantly deleverage on Wednesday.”
And looking at the overnight session, he was once again correct, as Tuesday’s rout appears to be contained, if only for now. Meanwhile, as Cudmore adds, “U.S. yields have plummeted, easing one of the main market stresses. Equities suffered, but there’s no sign of panic and it’s encouraging that well-owned FAANG stocks didn’t underperform. EM mostly held in okay, despite the negativity around that asset class. The recent oil correction eases some negative pressure for all the major Asia economies — China, Japan, India, South Korea — and yet the broader commodity complex is hardly collapsing.”
So putting all this together, Cudmore notes that “if anything, I find myself becoming bullish global equities — having been bearish for months and then reiterated my bearishness last week — and more positive on EM having turned bullish from bearish just this week.“
So was the Italian rout, which now appears to have been arrested…
… and resulted in a modest ~1% drop in the S&P, the capitulation everyone was waiting for, and is it indeed, as Cudmore now suggests, time to buy the dip? Read his full note below and decide.
All This Turmoil Clears Path for Gains in EM, Stocks: Macro View
Panic provides opportunities. The outlook for both EM and global equity markets looks better now than it has done for many months.
The incredible moves in Italy’s bond markets don’t warrant global deleveraging just yet. Last week, this column argued that an Italian debt crisis would become the dominant theme for markets. That view still holds, but it’s a theme that will take months to play out, not a few days.
Italy’s real problems will come when a fiscally irresponsible, anti-EU government takes charge. The earliest that’ll happen is August (and that assumes a definitive result at a July 29 election), but potentially not until 2019.
Until then, expect protests and maybe economic stagnation, but that’s hardly new for Italy and won’t threaten an imminent euro breakup. There’ll be plenty of volatile two-way trading in the interim and there’s no reason to price the worst- case scenario in just a few sessions.
The positive news is that many of the most complacent bullish positions have now been cleaned out. In early January, short volatility, tech stocks, EM and negative-yielding peripheral debt would have led a list of positions worrying investors. All of those asset classes have suffered corrections in recent months and look healthier as a result.
On top of that, higher U.S. yields were one of the chief catalysts for higher volatility and asset selloffs and they have now corrected significantly; 2-year yields are more than 25 basis points off their May peak while the dip is more than 30 basis points for the 10-year.
And the backdrop remains a world of global growth and strong earnings. I turned bearish equities, via this column, on Jan. 31 and reiterated that negative view as recently as one week ago. Now, the fundamental framework looks far more positive and the MSCI All World Index is 6.7% lower from when I turned bearish.
The oil rally is correcting and EM central banks are fighting back against the highest-profile idiosyncratically negative stories — Brazil, Argentina, Turkey and Indonesia. Most of the main reasons to be bearish EM have rapidly shifted the other way.
The final piece of the jigsaw needed to stir animal spirits is an easing of the dollar rally which caught so many offside. This column argued at the end of last week that we’ll soon see that component too, amid the crumbling rates support pillar for the dollar.
It’s understandable that we see some knee-jerk risk-aversion in the wake of Tuesday’s unprecedented bond moves. But there are plenty of reasons to see this as the final wave of weakness before a fresh leg of gains for both global equity markets and many EM assets.
Given the large recalibration of VAR metrics and leverage ratios for so many investors, volatility may remain, but the underlying direction may soon start being much more positive.