In the past month, now that stocks have stabilized on the hope, and at least one confirmation of easing by the ECB, BOJ, and PBOC and even the Fed, we have seen quite a few comparisons of the current market to that encountered during the post-LTCM bailout halcyon days of late 1998/early 1999. From Ice Farm Capital, to BofA, now that the early-2008 chart comparisons have taken an indefinite hiatus (at least temporarily), suddenly analogs to pre dot-com bubble mania are all the rage.
And sure enough, for the technicians out there all else equal, the following chart overlay screams Nasdaq at 6000 in 4-6 months.
This is how BofA summarizes it:
It could simply be 1998/99 all over again. After all, a “speculative blow-off” in asset prices is one logical conclusion to a world dominated by central bank liquidity, technological disruption & wealth inequality.
Back then, as could be the case today, a bull market & a US-led economic recovery was rudely interrupted by a crisis in Emerging Markets. The crisis threatened to hurt Main Street via Wall Street (the Nasdaq fell 33% between July-Oct 1998, when LTCM went under). Policy makers panicked and monetary policy was eased (with hindsight unnecessarily). Fresh liquidity combined with apocalyptic investor sentiment very quickly morphed into a violent but narrow equity bull market/bubble in 1998/99, one which ultimately took valuations & interest rates sharply higher to levels that eventually caused a “pop”.
The 1998-2015 analogy, for what it’s worth, is working for the Nasdaq (see chart above), which is currently bouncing hard, and leading the rally, after an 18% plunge. (Although it is not yet working for biotech which is consolidating after a 35% crash).
So if this is merely a rerun of the well-known pre-dot com bubble episode, what should one be positioned? This is how BofA would trade the "final melt-up on Wall Street."
What worked back then? What rose from the rubble of 1998? How would one position for one final melt-up on Wall Street? Table 1 illustrates it was an “überbarbell” of über-growth stocks (e.g. internet) and über-value (e.g. EM/Russia) that significantly outperformed in 1998-99. Why? Because 1999 started as a year of “max liquidity, scarce growth & distressed value” and ended with an internet bubble causing a significant rise in interest rates, growth & inflation.
So far has certainly been so good, if not for the near record NYSE shorts: "The October “pain trade” has thus been a big rally in risk assets, as predicted (albeit too early) by all our contrarian trading rules flashing “buy” signals in early-Sept. The ECB, the PBoC, US tech EPS and the fact that too many were positioned for the “event”, the recession, the default, the plunge below the 50 boom-bust line in the world’s PMI, all have caused a big squeeze in risk assets in particular S&P 500 back through its key resistance level of 2060."
And yet, while suggesting the appropriate trade if this were indeed 1998/1999, BofA' Michael Hartnett isn't buying it, for two reasons.
The 1998/99 redux risk aside, we believe the Big Macro Picture remains one of “Deflationary Expansion”, and the Big Market Picture is the "End of Excess Liquidity" & the “End of Excess Profits” over the past 12-months. That’s why we would recommend investors sell into new upside in risk assets in Q4.
Ironically, while “liquidity” was the bull driver of risk appetite in recent years, in 2015 it is the perception of “illiquidity” in fixed income & equity markets that has become a driver of risk aversion. This perception has been abetted by a non-stop period of "pain trades."
Here is the three part answer to "what prevents us BofA from getting more bullish now that risk has rallied":
First, positioning is not bearish enough to generate new highs in risk assets and sustain new highs. Cash levels jumped in recent months but clients never went UW equities (although there were significant outflows from High Yield funds, in excess of 5% of AUM in recent weeks). And the consensus never made recession the base case. In addition, as noted in our latest Flow Show (link), a number of our Trading Rules are flipping from “buy” to “neutral”. The Global Breadth Rule, the EM Flow Trading Rule & the Global Flow Trading Rule have turned neutral in the past week, and while the FMS Cash Rule & the Bull & Bear Index reveal high cash and bearish cross-asset sentiment, both have turned in a less bearish direction (see page 8).
Second, policy. The Quantitative Failure narrative failed this week. The ECB’s promise of QE2 in December was met by a lower Euro, lower bond yields and higher bank stocks. Quantitative Failure requires a lower currency, lower bond yields and lower bank stocks, thus signaling investor revolt against the ability of central banks to raise growth expectations. (Note true QE-apocalypse would be higher bond yields and lower bank stocks).
However, the old script of “I’m so Bearish, I’m Bullish”, a script that worked like a charm between QE1 and the end of QE3, no longer cuts it. Investors will no longer be satisfied simply by Quantitative Easing. They require “Quantitative Success”, and a success that is visible in corporate profits. This risk rally cannot be sustained if Fed hikes and/or ECB/BoJ/PBoC easing causes the US dollar to rally strongly, thus setting off another “death spiral” in EM/commodities/energy/HY and fresh round of EPS downgrades.
Third, profits. The growth of global EPS is currently negative. And the level of global EPS is down 4.2% from its February 2015 highs. The classic strong “year-end” rally in stocks & credit requires EPS expectations to rise. Without EPS upside, Q4 risk gains will prove transitory.
BofA's conclusion, and why new all time highs are problematic here:
As explained above, new highs thus require:
- The Fed to hike, without…
- The dollar rallying significantly because…
- European/Japanese/Chinese domestic demand surprise on the upside.
That’s a tough ask.
Yes... but... all that would take to cover the "ask" is for some central bank to unexpectedly announce that it will proceed to buy an unlimited amount of stock. Because not even Bank of America seems to realize that a market crash, now that every.single.central.bank has gone all in on the asset reflation trade, failure is not an option, and money will fall out of helicopters before central banks admit defeat and allow a repeat of the 2008, with the S&P falling to its fair value, somehere just south of 500 (yes, that $60 trillion in newly created debt in the past 7 years rising to $200 trillion, means that without central bank support, the global equity tranche is now non-existent).