BofA Survey Reveals The Biggest Market Risk: A "Stagflationary Bond Crash"

So much can change in just one week: where in the world "before Trump", every asset manager was prepared for "more of the same" gradual deflationary status quo grind under the Clinton administration, following the dramatic Trump victory everything has turned upside down, and now the overarching consensus - roughly a mirror image of what it was just last Monday - is for soaring inflation, rising US Dollar and risk assets, yet another "great rotation" out of bonds and into stocks, and perhaps an economic revival.

To be sure, in the latest just released BofA fund manager survey in which 177 clients managing just under half a trillion dollars were querried, the results were largely as expected as per the just reset conventional wisdom and as determined by the price action over the past 5 days.

In a nutshell, and as BofA puts it, "Inflation expectations surge", with global growth and profit expectations rise to one-year highs; inflation expectations soar to 12-year highs; number of investors expecting yield curve steepening surges by record amount…US election result seen as unambiguously positive for nominal GDP.

Here are some charts:

Global growth expectations jump to net 35% from net 19% last month. This is the highest reading in 12 months.

Global inflation expectations soar to highest % since Jun’04 (net 85% from net 70% last month).

Highest % of investors since Aug’13 think yield curves will steepen over the next 12 months (net 65% from net 31% last month). The is the biggest MoM jump on record!

Meanwhile, one the biggest laments heard repeatedly about the investing community, namely that it has been sitting on record amounts of cash, is now long gone: cash levels slump from 5.8% to 5.0% in Nov - the largest monthly drop since August 2009. According to Bank of America, this not yet a tactical negative... but it soon will be: a drop in cash to <4.8% in Dec would be a sell trigger, and furthermore a 1ppt fall in two months historically causes risk sell-off.

Just as notable as the cash inflow, has been the sector rotation: the election accelerated rotation into Banks, out of high dividend yield and bond proxies (e.g. Utilities, Telcos), and catalyzes buying of US equities, selling of Tech and Emerging Markets (biggest MoM drop since Feb’11). FMS shows growing conviction in “inflation trade”: majority of investors say cyclical rotation should continue “well into 2017”.

The chart above also leads BofA to recommend the following contrarian trades: long UK assets unambiguously contrarian (e.g. GBP = most “undervalued” on record). Long active vs. passive (FMS investors forecast market share of passive to rise to 40-49% equity AUM in 3 years). There will likely be a trade in “bond proxies” soon but our cyclical view of peak liquidity, globalization, inequality means the “yield” dam has been broken.

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In terms of future return drivers, everyone is looking at bond yields, which is odd considering that these have soared at a record pace in the past week, something whic at least the Fed model finds as very bearish.

Adding to this, a net 82% of investors expect higher long-term rates in next 12 months. This is the highest % since 2013.

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So what is the biggest risk according to the big money managers? According to BofA, the biggest tail risk is now a  “stagflationary bond crash”…crowded longs (Minimum Volatility, US/EU credit, long EM debt) remain vulnerable to further jump in yields. In contrast, political rhetoric to calm “protectionism" fears (which jumped to highest levels since 2009) would boost risk appetite.

Highest % of investors think protectionism is biggest risk to financial market stability since 2009.

FMS says biggest equity driver next 6 months by wide margin = Treasury yields (48%), followed by US dollar (24%).

And the punchline: stagflation expectations now close to 4-year highs as 22% of investors expect below-trend growth & above-trend inflation over the next 12 months.


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