Market Strategist Who Nailed S&P 500 This Year Has a Fed Theory
(Bloomberg) -- There’s one sell-side analyst who managed to predict this year’s volatile markets and he doesn’t come with a wizard nickname in recognition of his prognosticative skills.
Deutsche Bank AG strategist Aleksandar Kocic wrote earlier this year that the S&P 500 Index could hit a floor of between 2,300 and 2,400 as the Federal Reserve normalizes monetary policy. The benchmark equity index reached 2,351 on Dec. 24 and has since rallied 6.5 percent to about 2,500.
His prediction stands in stark contrast to many others on Wall Street in a year characterized by intense swings. As 2017 drew to a close, the median target for the S&P 500 at the end of 2018 stood at 2,855, according to a Bloomberg tally. Even Marko Kolanovic -- the JPMorgan Chase & Co. strategist dubbed “Gandalf” -- predicted only a modest uptick in volatility for the year.
How did Kocic nail the move in a year that saw many other professional forecasters founder as worries over economic growth, trade tensions and political gridlock whiplashed equities? With a relatively simple theory about the Fed’s impact on markets and the notion that the central bank “put” which has backstopped risk-taking is now being repriced.
“Despite all the political entropy, our view has been that the market is simply misreading the outdated and unreliable signals and making incorrect conclusions about the economy, and using that information to scale down on risk,” Kocic wrote in a Dec. 27 email to clients seen by Bloomberg. “Although the equities whipsaw continues around the Fed put, the strike around 2,300 (as we predicted in Feb and reiterated in October) seems to be doing all right.”
Kocic contends that years of quantitative easing after the financial crisis effectively saw the central bank suck systemic risk out of the market, forcing the beta -- or co-movement -- between equities and short-term interest rates to move higher as the Fed provided a backstop for risk and encouraged investors to snap up financial assets.
As the Fed withdraws its extraordinary policy and unwinds its balance sheet, the beta between equities and interest rates begins to normalize. Based on Kocic’s calculations, the “normal” beta between equities and yields during a Fed hiking cycle should be closer to 10 -- implying a 2,300 to 2,400 level on the S&P 500 -- versus the 30 beta seen earlier this year.
Kocic’s theory could have implications for the central bank as it tries to pare back monetary stimulus without overly roiling the markets. After 2008, the Fed became an emergency supplier of “convexity” -- or downside protection -- after the market mispriced risk in assets like “conventional callables, mortgages, credit, CDS, and structured products.” Kocic argued earlier this month that the central bank is currently shedding its role as “convexity supplier of last resort” in favor of managing convexity instead.
Still the Fed has to carefully reintroduce risk into the system as it tightens financial conditions and be in “constant communication” with markets, he said, at a time when some investors have criticized it for raising rates. Mohamed El-Erian, Allianz SE’s chief economic adviser, said in an interview Sunday that the central bank needs to “show that it is more sensitive to markets and what’s happening outside.”
A spokeswoman for Deutsche Bank said Kocic was unavailable for comment.
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