naked capitalism

Ah, just when you thought it might be safe to venture into the markets again, RBS sends out a red alert, warning private clients to prepare themselves for a full fledged rout in equities and bond markets in the next three months, with the S&P losing 300 points, or nearly a quarter of its value, by September.

That’s a bold and pretty specific call. The technically-minded believe that if the S&P 500 were to breach 1270 (closing, not intraday), the next support level is hundreds of points lower. In addition, the impact of inflation has not been factored into asset prices. The chart below (click to enlarge) illustrates how devastating inflation is to stock valuations. The S&P 500 multiple fell from over 17 to below 8 during the early 1970s, and pretty quickly too. However, then the impetus was the oil embargo, but note that as inflation became embedded, a bear market rally fizzled and the market hit even lower earnings multiples.

Now the flip side is forecasts like this have a way of not playing out according to script. Like the Heisenberg uncertainty principle, the very act of making such a projection influences the outcome. It may be that a mere reversal of the denial about the combination of the inability to treat fragile financial markets and inflation simultaneously will provoke a selloff (but it could be a grinding loss of confidence over 6-9 months rather than a speedy affair). Or as with the 1970s, there may be a now-unforeseen shock (one shudders to think, but at attack on Iran would send already high oil prices to ghastly levels, almost certainly precipitating a global recession).

From the Telegraph:

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

“A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist…

RBS said the iTraxx index of high-grade corporate bonds could soar to 130/150 while the “Crossover” index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets.

“I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names.

“Cash is the key safe haven. This is about not losing your money, and not losing your job,” said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate.

RBS expects Wall Street to rally a little further into early July before short-lived momentum from America’s fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.

“Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point,” he said….

The authorities cannot respond with easy money because oil and food costs continue to push headline inflation to levels that are unsettling the markets. “The ugly spoiler is that we may need to see much lower global growth in order to get lower inflation,” he said.

“The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets,” he said.

Kit Jukes, RBS’s head of debt markets, said Europe would not be immune. “Economic weakness is spreading and the latest data on consumer demand and confidence are dire. The ECB is hell-bent on raising rates…

Ultimately, the bank expects the oil price spike to subside as the more powerful force of debt deflation takes hold next year.