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With just 42 days trading days left until the S&P500 bull market becomes the longer of all time, Morgan Stanley’s chief cross-asset strategist, Andrew Sheets, writes that investors are now more sanguine about how much time they have until the next recession than at any point since 2010. “We’re 8 ½ years into an expansion, and many investors finally are finally confident that there is plenty of time left on the clock.” Sheets also notes that in client conversations, China is rarely mentioned as a growth concern (after causing angst for much of this period). All this is taking place against a backdrop in which key market elements are vastly different from a year ago (as we discussed earlier).
Morgan Stanley is not the only bank to urge clients to turn more skeptical, if not outright bearish.
As Bank of America Chief Investment Officer Michael Hartnett writes in his latest Thundering Word report titled suggestively enough “Charts of Darkness fo Apocalypse Dow”…
… “relative to consensus we remain bearish on financial assets” and notes the following:
we believe peak asset Prices in 2018 are consistent with peak investor Positioning, peak corporate Profit expectations, and peak Policy stimulus. We believe the peaking of the 3Ps is occurring in a late-cycle macro & market backdrop (in 42 trading days the S&P500 bull market becomes the longest of all time). We forecast low & volatile single digit gains for stocks, low single-digit losses for bonds, and relatively strong 2018 for cash, commodities and the US dollar.
And whereas Morgan Stanley’s Sheet laid out a qualitative explanation for his skepticism, Hartnett takes us through a visual landscape of his “charts of darkness”, which lay out the primary reasons for his bearishness, including:
- Quantitative Tightening takes liquidity growth negative in 6-8 months,
- trade war takes US tariffs to highest since mid-1970s,
- lead EPS indicators continue to weaken,
- EU doomed until German fiscal capitulation,
- US yield curve inversion just 36bps away
These are the “five profit and policy reasons” he remains bearish.
Presenting, Bank of America’s Charts of Darkness
1. Quantitative Tightening: YTD G3 central bank asset purchases of $125bn well below $1.5tn run rate of 2017; we estimate liquidity growth turns negative in 6-8 months; Fed tightening always triggers an event (Chart 2).
2. Trade War: new US tariffs set to boost US protectionism to highest level since mid- 1970s; further action on China ($200bn), autos ($350bn), NAFTA ($690bn) would raise tariff revenue as % total imports to levels not seen since 1946 (Chart 3); our own view is 2018 “trade war” really just 1st stage of new arms race between US & China to reach national superiority in technology, and protectionism inevitably on rise to address inequality.
3. Peak Profits: 2018 global EPS forecast robust (15.5%) but 2019 slipping (9.4% down from 10.4% in April); lead indicators continue to weaken (e.g. soft June South Korea exports, Chart 4).
4. German fiscal stimulus: we believe ECB tightening is doomed to fail as has been case in Japan past 30 years (implying 8bp ECB policy rate in 2030 – Chart 5); until Italy, migration, trade wars force Germany to capitulate on fiscal austerity (note German current account surplus staggering 8% of GDP while sharing a border with Italy – youth unemployment rates >33% – Chart 6) a case cannot be made for European banks.
5. Yield Curve: flattest US Treasury yield curve since Sept’07, just 36bps from 1st inversion since 2007; curve inversions have preceded 7/7 prior recessions since 1970 by 4 to 5 quarters (Chart 7).
* * *
So with all that in mind, one would assume that the BofA CIO would recommend bearish traders. Yes… and no.
The reason for Hartnett’s ambivalence is that much of the potential downside appears to already be priced in, and as a result, investor positioning close to triggering contrarian “buy signals” for risk assets in coming months.
- The BofAML Bull & Bear Indicator has dropped from 8.6 in January to 2.9, a two-year low, close to first buy signal since 2016 (Chart 8).
- The BofAML Bull & Bear Indicator has given 15 “buy signals” since 2002 (link); the median return for MSCI ACWI is +6.1% in 3 months following
And, in light of the approaching “extreme bear” sentiment print, Hartnett reminds his readers that “as always the best asset to buy is “humiliation”, which occurs when extreme bearishness combines with a financial event and/or recession risk, e.g. Feb’16 when BofAML Bull & Bear Indicator @ 0.0 coincided with China hard landing, US recession fears, HY credit events as oil dropped below
We’ve argued for an SPX 2550 to 2850 range this year; a move to the bottom of this range could elicit a buy signal and nice trading rally for distressed markets (e.g. EU equities, EM debt).
Just like earlier in the year, ahead of the February VIXtermination and during the market blow-off top phase when he urged client to buy stocks if the S&P slides to 2,550, which turned out to be the precise market floor so far, Hartnett writes that a “big, exciting entry point at levels below 2550 first requires extreme bearishness to coincide with 2019 recession fears (weak US labor market data) and further credit contagion (global debt = 3.5X GDP or $240tn) causing Fed to pause hiking cycle in H2.”
He concludes: “we’re not there yet.”
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