In a unexpectedly gloomy note from BofA's Chief strategist David Woo, titled "Sell before it's too late", the analyst writes that this is "a market with risk off written all over it" largely as a result of a string of weaker-than-expected US data over the past week, which "has only strengthened our view that the US economy is losing momentum" and adds that the culprit is the lack of progress in tax reform in Washington.
As Woo explains, the reason for his gloomy economic view is that companies after companies across the country have been telling the bank lately that they are withholding major decisions on hiring and investment until there is greater clarity on tax reform, which he says "should come as no surprise."
Running a business without knowing what taxes you will be paying, whether interest and labor costs will be tax deductible, how long you have for capital expenditure depreciation is like driving at night without headlights. If you can't see, you slow down ? the increased uncertainty around tax reform has become a damper on economic growth. The data are bearing out this wait-and-see attitude. Core durable goods orders have been flat for three consecutive months and the three-month moving average of nonfarm payrolls slowed in May to the most sluggish pace since the Eurozone crisis in 2012
What did surprise Woo is that against a backdrop of a rolling over economy, the Fed doubled down on its hawkish tone and wonders "what it sees ("solid" job gains, businness fixed investment that "continues to expand", risk to the economy being "roughly balanced") that we do not."
His answer: "Can it be the case that its hawkishness was prompted by something other than its reading of the economy? For example, is it possible that the Fed has become concerned about the recent surge in the equity market, especially tech stocks that has been feeding off low interest rates and low volatility? According to our equity strategists, the P/E of the tech sector (19x) is currently at its highest levels post-crisis while the EV/Sales ratio is at the highest sinec the Tech Bubble"
Woo adds that whether the Fed's hawkiness was indeed intended as a warning shot to tech stocks or not, momentum behind the recent tech rally was already fading even before the FOMC meeting. The fact that large cap active funds have never been more overweight the tech sector in the history of our data and the possibility that there could be a bigger correction ahead make us think that the balance of risks for both US rates and USD/JPY remains on the downside (notwithstanding the Fed's plan to hike one more time and to start shrinking its balance sheet this year).
It's not just tech however, because as the BofA strategist also notes, "the price action in the energy market is also raising a red flag in our eyes. In the face of continued inventory build and increasing rig count (Chart 2), WTI front month contracts fell to a two-month low last week.
BofA's commodity team maintains its view that supply/demand balance points to a deficit of 830 thousand b/d over 2H2017 but is becoming concerned that hedging ratios among North American producers for 2018 are only a quarter of their normal levels. As Woo warns, if WTI breaks below $44 per barrel (it is currently at $44.68), $38-40 levels could be in play.
To be sure, today's hawkish comments by Dudley in light of last week's increasingly disappointing economic data suggest that the Fed is indeed focused on "other things" although if Yellen is hoping to mute the relentless grind higher in stocks, one look at today's market action shows that she and the Fed will both have to try much harder...