For the past year BofA Chief Investment Strategist, Michael Hartnett, has been one of Wall Street's gloomiest strategists (perhaps just below Albert Edwards and Michael Wilson on the permabear scale) warning that global markets are on the precipice of a very ugly turn of events, and predicting that 2022 will unleash a "rate shock" that will hammer risk assets, and as 2022 gradually rolls out, doling out major pain for the bulls, his predictions are finally coming true.
But for all the complaints from stock investors, nowhere is the pain more acute than in the White House, because as Hartnett writes in his latest weekly Flow Show note, US inflation is up from 1.4% to 7.0%, while Biden's approval rating is down from 56% to 42% past 12 months. One can almost imagine what Biden told Powell during that renomination phone call...
As Hartnett explains for the cheap seets, inflation = economic and political problem, writing that Joe needs 50bps from Jerome at Jan FOMC. And while Biden won't get it, the BofA strategist notes that the Fed will be very hawkish next 9 months, "so short the winners of Fed’s liquidity supernova - tech, IG, private equity."
The take home from the above is that after a decade of Fed desperation to hike inflation, the central bank finally got what it wanted... and is now trapped because, as Hartnett lists:
- inflation is off-the-charts,
- oil prices strong,
- supply bottlenecks remain, with China freight prices at all-time highs...
... and the less-acknowledged G7 unemployment rate (@ 4.5%) close to 40-year lows = wage growth..
And while it is like beating a dead horse by now, Hartnett - who has written about this topic extensively - notes that the coming "rates shock" will be global in ’22, while the deflation of long duration bonds (Austrian 100-year bond -34% in price terms) is leading deflation of long duration equities (biotech, software, solar, ARKK…).
Which brings us to the core of Hartnett's note, which is his explanation of the market's latest "conundrum" - the drop in the dollar, which as the BofA strategist writes is getting smoked despite 7% inflation, <4% unemployment, and a behind-the-curve Fed. Why? Because global investors' belief is US fading fast; dollar debasement = yields up & dollar down = 1970s, when cash/commodities outperformed stocks/bonds. That, in a nutshell, is ’22 thus far).
Yet a dropping dollar doesn't mean "cash is trash" - just the opposite (curiously, every time Dalio says Cash is trash, the market crashes within 3 months): as Hartnett explains in a section on "asset allocation", cash outperforming stocks and credit rare, and has happened just twice in past 30 years - 1994 and 2018 - both "Fed-shock" years... but the stagflation era of 1966 to 1981 saw cash outperform stocks & credit 7 out of 16 years (Table 1).
And like every stagflation, we see a furious response from central banks which Hartnett dubs simply "The Tightening": as of this moment, EM leads largest global tightening wave since 2011 past 6 months 49 global rate hikes vs 7 cuts (here one can note that the big story is not the coming tightening cycle from the Fed but the biblical easing that will follow).
But before we get the easing, we need to hike...a lot: inflation YoY in US, UK & Europe is currently 7%, 5%, 5%, and if inflation continues to rise 0.4-0.5% MoM (the average pace in '21) over the next 6 months, then inflation will hit 6% in US, 7% in UK, 6% in Europe "making total mincemeat of Fed/BoE/ECB inflation forecasts 2.6%/3.4%/3.2%."
So while the tightening is coming, the inflation is already here, and as Hartnett puts it simply, inflation always precedes recessions:
- late-60s recession preceded by consumer price inflation,
- 1973/4 by oil/food shocks,
- recession of 1980 by oil,
- 1990/91 by CPI,
- 2001 by tech bubble,
- 2008 by housing bubble
... and the slower the Fed reacts - here Hartnett again notes that the Fed should hike 50bps on Jan 26th - on fears of upsetting Wall St, the more inflation & recession risks grow, and the more likelihood US dollar debasement scars 2022.. albeit great for EM/commodities.
To be sure, the coming recession won't be just in the markets, it will hit consumers especially hard.
Why? Because the best consumer news are now behind us - as we noted this morning, retail sales are 22% above pre-COVID levels while payrolls up 18mn from lows but still well below pre-covid levels.
As a result, in 2022 consumers face inflation annualizing 9% (food 23% YoY, heating 50%, rents 13%, house prices 18%), real earnings falling 2.4%, synonymous with recession – see 1974, 1980, 1990, 2008, 2020...
... while stimulus payments to US households evaporating from $2.8TN in ’21 to just $660bn in 2022, meaning there is no more buffer from excess US savings (savings rate = 6.9%, lower than 7.7% in ’19…and as we repeated all the time, the “rich” hoard the savings), and as we said this morning, a record $40bn MoM jump in US consumer borrowing in Nov'21 sign to us that consumer starting to feel the pinch.
As a reminder, the US middle class has spent virtually all of its "excess savings" (according to MS just 1/3 went to the bottom 80%) and as a result, credit card usage in November exploded to an all time high pic.twitter.com/zcORyqH28w— zerohedge (@zerohedge) January 14, 2022
But while consumers patiently await for purgatory, Small Business are already in recessionary hell: the number of small businesses saying inflation/labor costs/poor sales the #1 problem is highest since 2010; this has historically coincides with recession.
Finally, there is the Profit Recession, where things get funny, because while all predict multiple contraction, few predict EPS contraction, and yet…the BofA global EPS model predicts marked deceleration from 40% last summer to 5% next summer (model driven by China FCI, Asia exports, global PMI, US yield curve), and could turn negative in the second half!
Hartnett is certainly right that nobody is prepared for what's coming: the latest weekly fund flows showed a massive $30.5bn inflow to stocks ("nobody is short the equity market"), $0.1bn from gold, $2.9bn from bonds, and the largest outflow from cash since Sept 21, at $43.5BN.
Rounding out his apocalyptic views, Hartnett continues to think the S&P will test 4000 before 5000, delivered by <$200 EPS & <20x PE
Finally, this is how Hartnett is trading the coming apocalypse: bearish, negative credit & stocks returns in ’22 driven by "rates shock" H1 & likely “recession panic” in H2.
- 1. volatility, high quality, defensives on tighter financial condition;
- 2. oil, energy, real assets on inflation (Chart 6);
- 3. EAFE/EM banks on reopening;
- 4. Asia credit on (very) distressed yield (Chart 8).
- 1. IG & HY bonds on Quantitative Tightening;
- 2. short private equity & broker dealers on wider credit spreads;
- 3. short tech/Nasdaq on higher rates/less capital flow from Europe/Asia.
There is more in the full report, available to professional subs.