I will never forget last week's stock market carnage. Global equities lost $5.2 trillion in value. The Dow Jones plunged 2,000-plus points, with two 1,000-point falls, its worst week since the post-Lehman meltdown in October 2008. The Chicago Volatility Index has tripled to 34 as I write as fear replaced greed with a vengeance. The 2/10 US Treasury note spread has widened to 75 basis points, a telltale signal that investors fear inflation risk. Like Paul Volcker, Alan Greenspan and Ben Bernanke before him, Fed Chairman Jay Powell takes office amid a financial crisis.
The era of central bank easy money is over. The Fed will yank $20 billion a month from the money markets as it shrinks its balance sheet. This has led to higher US short term rates and a bloodbath in the Treasury bond market. Readers of this column should not be surprised since I outlined precisely this scenario in 2017. The valuation metrics of US equities have fallen from 18.5 to 16.4 times forward earnings, though post tax reform EPS growth will be robust. The swift, brutal 10-13 per cent fall in US and global equities is a correction in a secular bull market, not the primal scream of a bear market. Friday's close was a positive as buyers emerged when the S&P 500 index traded down to its 200-day moving average at 2,540. Yet I hear about busted hedge funds, radioactive vol ETFs, horror stories on trading desks, margin calls - the spikes in volatility and volumes alone tell the tale. The untold billions in risk parity asset funds will have to liquidate equities since volatility has spiked above their target range. Yet Ursa Maxima will only come with recession, impossible in 2018.
The risk-reward calculus on the Stoxx Europe 600 index at 368 (as I write) is utterly compelling. Europe now trades at a three full-point discount to Wall Street at 13.8 times forward earnings. True, the spike in the 10-year German Bund yield means that valuations should compress - as they did so traumatically last week when risk did a Rip Van Winkle with a vengeance. Yet Europe is also a play on the acceleration in the global economy as the rise in German and French exports attests? Italy? Political noise, even though the idea of Silvio Caesar as an octogenarian kingmaker in Rome is surreal. German politics? A non-issue. The Grand Coalition will ultimately embrace the Merkel-Macron vision of "mehr [more] Europe".
The failure of the US dollar to attract a safe haven bid and Brent crude's resilience at $67 tells me that last week was a stock market event, not a 2008 style systemic financial crisis. High-yield spreads have widened but not gone ballistic - for now. I expect the ECB will postpone the end of its planned taper in September and thus ease pressure on the uber-euro, which will be a steroid shot for the Stoxx Europe 600. The index's volatility at 18 also makes now an attractive entry point for Europe. The national PMI's demonstrate the eurozone economic growth momentum is intact. I need to see Spanish and Italian indices outperform the German DAX and the French CAC-Quarante to green light my European high-beta basket and, as always, track the earnings revisions cycle in real-time. There is a time to own America and there is a time to own Europe. This is the time to own Europe.
I was horrified to see the world's bluest of blue-chip biotechs slammed even before the latest market swoon. Nathan Mayer Rothschild advised that "buy when there is blood on the street - and there is definitely blood on this street. This is the ultimate event driven (FDA approvals, pipeline milestones, new drug compounds, royalty and licensing deals, etc.) so I will not name names but note that ImmunoGen shares went up four times in 2017.
I was stunned to see the Nikkei Dow's 700-point rise flame out in Tokyo on Wednesday. Yet this does not change my conviction that the Empire of the Rising Sun will be one of Asia's great investment themes for me once Mr Market (Market - San?) calms down. I have made no secret of my conviction that Kuruda-san (the second arrow of Abenomics!) will be reappointed governor of the Bank of Japan in April, that the yen will trade in a 107-116 range against the US dollar and that Sony, Toyota and Softbank are my favourite Dai Nippon blue-chippu's. Arigato gozaimasu!
The writer is a global equities strategist and fund manager.
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