The Bad News, The Good News… And What To Do

The Bad News, The Good News… And What To Do

Authored by Bank of America’s Chief Investment Officer, Michael Hartnett

Key takeaways

  • Market cap loss: $6tn in global stocks, $4tn in US stocks in just 6 trading days.
  • Credit “ghost in the machine” remains biggest market risk.
  • We say March will be policy panic month, risk to rally.

The bad news

Credit event: risk of credit event surging…extreme bond ETF volumes (e.g. HYG), ominous breakdown in levered loan ETF BKLN (Chart 2), CDS widening; exogenous shocks often expose bad leverage (e.g. Kobe earthquake led to Barings, Asia crisis… LTCM); liquidation of $1tn annualized bond inflows exposing systemic “ghost in the machine” remains biggest 2020 market risk (catalyst for policy response).

Macro: risk of global recession rising…BofA economists cut 2020 global growth to 2.8%, lowest since 2009 (link); BofA global 2020 EPS model forecasts -3.5% (vs. flat consensus)…model inputs (global PMIs, Asian exports) deteriorating (Chart 3).

Peak globalization: COVID-19 reminder that US/China tension, bifurcated global supply chains, competing technology standards…all negative for corporate profits in 2020s.

Politics: Oddschecker.com shows probability of Sanders victory in Nov’20 election @ 26%, up from 3% Oct’19 (Chart 4); US political risk hitting US$, helps explain surprise YTD outperformance of China stocks (A-shares) vs. S&P500.

Big Top: we had it coming…SPX highs, gigantic bond inflows, record low IG default risk, Microsoft, Apple, Google, Amazon all >$1tn, “toppy” corporate behavior; new lows in bond yields popped “irrational bubble” (we thought it would be Q2); “Showtime” for markets…big secular monthly floors for stocks (SPX 3000, NYA 12000, MXWD 500) must hold to prevent “Big Top”, end of bull market narrative (credit signals poor – Chart 5).

The good news…

Policy: “markets stop panicking when policy-makers start panicking”; March = policy panic month; policy-makers behind-curve, have 3/4 weeks to prevent small businesses cutting employment US & EU; Fed cuts 25/50 bps + China/Europe fiscal stimulus + semblance of global policy coordination = calmer “animal spirits” + risk rally; yield curve steeper this week, and fears of policy impotence, ironically, will boost easing impact.

Bigger PictureYCC+MMT: crash/ recession worries accelerates Fed shift to Yield Curve Control (YCC – heavily hinted last Friday by Fed Governor Brainard) and “fixed” low rates; also accelerates shift from QE to Modern Monetary Theory (MMT) to finance fiscal spending frenzy in coming quarters…will mark crucial low in inflation expectations.

Price: BofA CTIs models today show US & EU stocks extremely oversold, US Treasuries extremely overbought; BofA Global Breadth Rule closed at 62%, could imminently hit “buy signal” of 88% (of MSCI country indices

Positioning: BofA Bull & Bear Indicator peaked @ 7.1 Jan 22nd; now 4.6 (Chart 1); $20bn equity outflows this week = 19th largest past 15 years & 3rd biggest week HY bond outflow ever ($6.9bn) signal capitulation begins; record week of tech fund inflow ($2.6bn) & 7th most into IG bond funds ($11.8bn) shows capitulation incomplete.

What to do

Watch: decline in gold & Treasuries to signal panic over; decline in US IG bonds to signal its just beginning; key monthly floors of SPX 3000, NYA 12000, MXWD 500.

Buy stocks: we adjust 2020 EPS of $175 to $160 (as a 40% probability of recession means 8% EPS haircut) and apply policy reaction/yield collapse PE of 17-18X…says SPX 2880-3040 good entry point back into S&P500 (Chart 7).

Barbell stocks: 1998 analog (policy panic leads to upside) says own barbell of extreme growth and extreme value…long US Tech/FAANG and long “value ghettos” of Asia cyclicals/FTSE/oil.

Sell Treasuries: Fed panic to steepen yield curve; Treasury ETF TLT currently 2SD overbought (Chart 8).

Diversify via commodities & cash: use rally to position for rise of stagflation (demand-led lower growth, supply-led higher inflation; note in stagflation shock of Dec’68 to Sept’74 portfolio 60-40 stock-bonds dropped 5.5%, while portfolio of a 25-25-25-25 stock-bonds-commodities-cash rose 31.4% over period (Chart 9).


Tyler Durden

Fri, 02/28/2020 – 14:10

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Author: Tyler Durden

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