Q1 2017 will likely be the weakest period for economic growth of any rate hike since 1980; stock market earnings expectations are tumbling; uncertainty about the Trumpian pillars of stock market strength are surging, and various 'risk-on' asset classes around the world and breaking bad.

As RBC's macro strategist Mark Orsley previously remarked, something has dramatically, and suddenly changed in the market in recent days, as confirmed by bank's macro model provider. To wit:

There is another interesting force at play in equities that deserves to be flagged. The good folks at QI (our Quant macro model provider) flagged to me that their r2 on SPX  has been falling precipitously.

This means their model which incorporates hundreds of different factors is now unable to explain why S&P's are moving. Previously the main drivers of S&P's were well explained by 1Y forward earnings estimate, inflation, growth, credit spreads, energy prices, and real rates but that is no longer the case.

That means S&P's are going through a regime change and typically when the r2 falls this way, it is a red flag and caution is warranted.

And RBC's head of cross-asset strategy Charlie McElligott notes, it has become even worse in recent days...

The Quant-Insight Model has collapsed further to 33% - a sign of "real time" macro regime-change, which has marked prior volatility 'gap' periods.

As McElligott previously detailed, The incredibly-stable macro regime of the past year-and-a-half {the feedback loop we’ve pounded into your brains: 1) inflation expectations, 2) credit spreads, 3) equity vol} expressed by both the standard (83d rolling) and long-term (250d rolling) models is now seeing their respective R^2’s drop precipitously.

What does that mean in English? The macro factor models are losing their ability to ‘explain’ the index moves. Currently both models’ R^2’s are now at 43% and 57%, respectively, from highs near 90%. Although the historical data set is not deep, you can see in the charts above (specifically featuring the long-term model) that the prior two instances where the R^2 dropped through the 65% “trigger” in the long-term 250d rolling model, we have seen a concurrent DOUBLING + in VIX through the trough and return through 65% “confidence” period, as the macro regime evolves and ultimately “firms.”

 The equities inflow story continues to be robust (as do jobs and survey/‘soft’ data), but I believe there is a heightened risk of an equities drawdown occurring alongside:

1) further fiscal policy implementation delays (taxes and infrastructure an ’18 story best-case with ACA, immigration, SCOTUS, wiretapping and Russian messes),

2) the current crude sell-off “knock-on” effect” across assets (potential for VaR episode) and

3) tightening of financial conditions will likely too see that inflow euphoria abate in coming months, as it is also likely the economic surprise ‘beats’ mean-revert lower as well.