The Smartest Man in Global Capital Markets on When the Music Will Stop

By Joe Digiammo  MAR 15, 2013 10:58 AM

A secret top source provides his outlook on equities, credit markets, Asia, and how long the current market trend will last.

 


Author's note: Back in July, my firm, Mischler Financial, featured "The Smartest Man in Global Capital Markets" for the first time. We were not able to identify him by name, nor can we now, but we can tell you that he is a respected international banker at one of the world’s largest financial institutions. We can also tell you that he has been spot-on since the summer, both in time frame and levels. (See the end of this article for a reprint of his July commentary, which you can judge against the current market situation.)

Our access to the "The Smartest Man in Global Capital Markets" is through Ron Quigley, Mischler's Head of Fixed Income Syndicate and Primary Sales. Ron had a chance to speak to his source recently about where the markets are going now and over the next few months, looking into 2014. What follows is quoted directly from that conversation. Enjoy! (With thanks to Ron!)


The Outlook 

So, it's mid-March 2013 and, the S&P 500 (INDEXSP:.INX) is at 1550, right where I said it would be nine months ago. Allow me to update my thoughts as to where we go from here; vastly more relevant than where we have come from:
 
The three major drivers of equity index valuations have been:
 
1. The generational low ownership structure of the asset class.
The major brokerages went into the end of FY 2012 with about 38-40% of total assets in equity-related securities; that has crept up to about 43% in the year-to-date move we have seen to the upside.  This remains meaningfully below the norm for the 1980-1990s, which was estimated around 65-70%.  Of course, if one subscribes to the PIMCO mantra that the equity culture is effectively "dead": (they have been wrong), then maybe nothing changes.  If, however, Washington can be functional, the equity culture will continue to resurface as that's what the Fed wants.

2. The historically overvalued nature of just about all the alternatives asset classes (i.e. fixed income).
Just about every aspect of the fixed income asset class is overvalued.  From IG bonds to HY, from EM to REITs, and from MLPs to Preferreds, et al; the excessive liquidity situation has effectively arbitraged yield-to-maturity to historically low levels across all these product lines.  It is quite possible, arguably likely, that this situation will persist a bit longer as the Fed maintains its QE stance and effectively provides a "backstop" to valuation deterioration. One day, this will end. We will get to that.

3. Expectations of continued upward revisions to US corporate earnings that may result in more multiple expansions, so long as Fed policy remains so accommodative.
I see virtually no evidence of deteriorating US corporate earnings profiles; most companies I meet with are reasonably bullish on profits and some are beginning to even contemplate the prospects of pricing power as the consumer has remained active.

All the talk and speculation regarding a 5-15% correction has almost assuredly postponed that eventuality.  What I do see evidence of around the world is the following:

In conclusion, it's true that equity markets are a reasonably accurate 4-month-plus leading indicator.  It is more true that credit markets are at least two to three months ahead of equity markets.  Everyone needs to almost forensically analyze the global credit markets for signs of weakness; this is going on everywhere I go.  However, given the Fed's remarkable, borderline Darwinian, approach to things, it is clear to me that they will prolong their theatrics throughout FY 2013.  At some point in 2014, however, they will need to seriously articulate an exit strategy; this will be done in "spurts" versus any major surprise.  Bernanke hates surprises; he knows Greenspan was most upset about how things played out in February 1994.  This will be telegraphed so that there is no room for misinterpretation.  The markets will move very, very quickly.  Issuers need to "continue" to pre-fund.  Near term, the S&P has hit my March-April target of 1550-plus.  If one tries to "quantify" the impact of the sequester on the S&P, it amounts to only 20-25 points arguably. 

I see the S&P continuing to frustrate the majority (that is what markets do).  It may hit 1560-1580 prior to actually having a legitimate correction of 5-10%.  There is so much liquidity awaiting deployment upon a pullback that the pullback will be quick.  Later in the year, it's very likely we'll see 1600-plus on the S&P (September-November).  In my view, the market will be a good sell at that point, so will many credit products.  There is no way the Fed can shift its policy stance concurrent with having to immunize a $4 trillion balance sheet going into the end of a fiscal year.  2014 is likely to be challenging.
 
Enjoy this while it lasts.

Also see: 12 Cognitive Biases That Endanger Investors

The Smartest Man in Global Capital Markets; Commentary From July 2012:

Blackstone (NYSE:BX) has its prognosticator in Byron Wien. You’ll recall his recent blog in which his trusted source forecast an end of Europe. The seer was referred to only as “The Smartest Man in Europe.” Generally speaking, Wien has often quoted his brilliant, worldly, and wealthy oracle over the past decade.  Unfortunately, after much digging, our only profile of Wien’s source is that he is 90 years old, owns a Bentley and a private jet, and lives in one of the Cote d’Azur’s three Caps, which would pinpoint him in either Cap d’Antibes, Cap d’Ail, or Saint-Jean-Cap-Ferrat.  One would think that should pretty much be a giveaway, but if you know anything about the French Riviera there are many wealthy old people who would fit the bill.

Today, our intelligence comes from a very respected international banker at one of the world’s largest financial institutions.  We could also characterize the person as brilliant, worldly, and wealthy, but we prefer to pitch the person as much more down-to-earth, as he would want.  There is certainly no hot air here, only substantive macro insights.

Here are the takeaways straight from our source’s mouth. We hope it’s revealing and helpful:
 
On QE3:
QE3 is a certainty. It will happen in August. It will be $500 to 800 billion in US Treasuries and mortgage-related securities. Effectively QE3 is the US Treasury leveraging the Fed to effectuate the greatest liability management transaction in history by buying high-coupon, long-duration US debt in lieu of issuing low-coupon, short-duration risk and thereby optimizing the capital structure of the USA.  One of the world’s largest private banking networks in the world ($2.3 trillion) has 40% of assets in equities versus 70% in the period from 1980 through 1997.  In other words, the asset class is massively underowned. 

QE3 will lower UST 2-year  0-10 bps; T5-year 50 bps and the T30 down to 1.25%.  Furthermore every client with half a brain will be selling into this.  Expect to see a “massive” increase in issuance of hybrid securities/perpetual bonds being planned everywhere.  Equities are vastly underowned and they will, as a result, go up -- way up! The market always frustrates the majority. Everyone is currently off-sides on equities.
 
On China:
China has access to more policy levers to insure 8% GDP growth in Q3 and Q4 2012.  The People’s Republic’s big issues will start in fiscal years 2013-2014.  China Merchants Bank (PINK:CIHHF), for example, is already seeing a bigger rise in bad-loan provisioning and lower good-loan growth than Western equity analysts think.  The CEOs of two large Brazilian companies, Vale (NYSE:VALE) and Petrobras (NYSE:PBR), are starting to plan for China to "hit a wall" in 2015-2018. Essentially, China will look OK through April 2013 then big problems will hit the country.
 
On the EU:
Europe will not implode. The IMF, in particular, is very well advanced regarding the Spanish banking system, almost loan by loan.  The IMF has more than a $1 trillion USD-equivalent firewall versus Europe, Middle East and Africa (EMEA). Europe will not fail. The biggest concern is the arrogance and reluctance of France to distance itself from its postwar culture of entitlement.  It is developing into a huge issue at the highest levels of government. Despite that, however, the realities of "globalization" indicate that a transparent public barrage of verbal attacks between Paris and Berlin are a pre-condition to Europe righting itself.  Recently on a high-level trip with the Italian Finance Ministry and the country’s largest companies, including intensive meetings with over a dozen CEOs, it became obvious that every single company is not standing still.  Meetings were to advise on many multiple cross-border acquisitions. There's lots of capital formation among the Italian small/mid-cap corporations and this all translates into good stuff.
 
In conclusion, The Smartest Man in Global Capital Markets said the following: “I hate nominal yields; be careful of commodities despite QE3; gold could go higher, but briefly; I love the USA; sell Brazil; China will be OK but only through April 2013.  In terms of Asia, I am negative on India and Indonesia.  I like Vietnam, Myanmar, Sri Lanka, and the Philippines."
 
One added sound bite from my interview with The Smartest Person in Global Capital Markets: Not all but most of the talking heads on TV have no idea what the hell they’re talking about. And that’s no BS.
No positions in stocks mentioned.