BofA: "Central Banks Are Now In A Desperate Dilemma"..."Start Buying Volatility"

One week after the second biggest weekly inflow to Wall Street on record, the "risk on" rotation ended abruptly in the ensuing five days, when as Bank of America writes overnight, it observed "Inflows to structural "deflation", outflows from cyclical "inflation"; with oil the "poster child" for this trend."

Half a year after central bankers around the globe rejoiced that the Trump victory may finally spur the long-delayed period of global reflation, that hope is now dead and buried (even as the Fed keeps hiking into some imaginary inflation wave) which BofA's Michael Hartnett observes not only in asset prices, but also in fund flows.

As the BofA strategist writes in a note aptly titled "Bubble, bubble, oil & trouble", the big flow message "is structural "deflation" dominating cyclical "inflation" (oil price is the "poster child" for victory of deflation): outflows from TIPS; first outflows from bank loans in 32 weeks; outflows from US value funds in 8 of past the 9 weeks; 1st inflows to REITS in 11 weeks; biggest inflows to utilities in 51 weeks."

More importantly the tsunami of recent inflows, mostly into US equities, appears to finally be slowing: following sizable inflows to equities & bonds last week ($33.5bn in aggregate), a week of modest flows: $5.0bn into bonds, $0.5bn into equities, $0.8bn outflows from gold. Additionally, after the recent "tech wreck", flows show confirm that contrarians - or simply stopped out algos - have flirted with sector rotation as inflows to energy ($0.4bn) were offset by outflows from tech ($0.2bn) & growth funds ($2.1bn);

Looking at BofA's client base, Harnett notes that private clients were also sellers of tech past 4 weeks; and adds that despite the 20% YTD decline in oil price, energy funds ($2.8bn) and MLPs ($2.6bn) see inflows in 2017.

As we have extensively discussed, institutional bullishness remains restrained by the structural shift from active to passive courtesy of $3.1tn inflows to passive bond & equity funds vs. $1.3tn outflows from active bond & equity funds (since 2007 - Chart 2); Hartnett says that the "shift is deflationary for both active & passive managers."

Those who claim that there is no bubble may find some enjoyment in the next observation by Hartnett: "you'll know it's the "big top" when Millennials start buying (new investors a classic late-cycle signal); recent survey by AMG shows millennials have just 30% in equities versus 46% for older age groups."

And while Hartnett makes another case for the lack of irrational exuberance...

Thus far, limited irrational exuberance in flows/positioning; and important to note investor "greed" is much tougher to end than "fear"… Nasdaq fell >10% on 6 separate occasions in 12 months leading to bubble peak in 2000 … and greed easier to pop if bond yields rising (Treasuries rose 200bps in '99, JGB yields rose 250bps in '89).

... he concedes that there are plenty of signs of Wall St excess in 2017:

  • S&P 500 at 2620 means US stock market cap as % of nominal GDP will hit an all-time high;
  • In 2017, global issuance of High Yield bonds is annualizing $499bn, a record high;
  • Argentina, a country that has spent 33% of the past 200 years in default and has defaulted 3 times in the past 23 years, has just announced a 100-year bond offering;
  • Facebook's market cap now exceeds the market cap of MSCI India (FB has 18,800 employees, India has 1,280,000,000 people);
  • Inflows to tech funds are rising in 2017 at their fastest annualized rate (21% of AUM) in 15 years;
  • In a classic late-cycle signal, global investors are long the Eurozone (June FMS shows 3rd largest overweight on record);
  • And finally, the MOVE index of US Treasury market volatility is almost at an all-time low; S&P realized vol at 20-year lows.

What does it all mean from the man who coined the "Icarus Trade" concept (and which will soon be replaced with the "Humpty Dumpty market: it means that we are now just months from the "big top":

"Greed/Icarus take time to kill but peak liquidity (Fed now wants vol) & peak profits (chart) = big top in autumn"

Hartnett's conclusion is, as usual, both enlightening and chilling: 

Central banks, the reason behind high asset prices and low vol, are now in desperate dilemma: politically unacceptable for bubble on Wall St, but central banks will be tightening into deflation; inflection point for volatility is upon us and we recommend investors buy volatility; we stick with view the that Icarus followed by Humpty-Dumpty when peak liquidity & peak profits (Chart 1) combine in the autumn; Fed tightening in 2017 could easily be followed by easing in 2018, in our view.


silverer Stan522 Fri, 06/23/2017 - 09:29 Permalink

They don't have far to go to finish the job. Since 1913, the Fed has already confiscated $0.93 of every dollar. Depositors should have followed your advice starting in 1913. You negative poster is a moron, or has something to gain from everyone losing their money. Dodd-Frank legislation wrote into law that you don't "deposit" YOUR money in a a bank, you now "INVEST" in a bank. Oops, you lost your INVESTMENT. Sorry. Think the FDIC covers you? Think again. During Obama's last term the criminal US congress passed legislation along with raising the spending cap to cover the bank's toxic derivative bets in the market casinos with insurance from the FDIC (meaning taxpayers, actually). So the 50 trillion in derivatives bets and the 8 trillion or so in working people's bank deposits have a whopping 95 billion set aside by the FDIC to cover losses. I guess your negative poster doesn't know their ass from their elbow, or they are just a financial masochist. Either way, you are right. Get your money out of the bank; and not just the big banks, ALL of the western banks, as they are bound by regulation to run the operation by the central bank rules.

In reply to by Stan522

lester1 Fri, 06/23/2017 - 09:01 Permalink

Desperate Dilemma?.. No! Until the Federal Reserve is fully audited, they will continue to lie, buy stocks, and manipulate markets daily to protect the assets of the wealthy .01% !

stewie Herdee Fri, 06/23/2017 - 10:48 Permalink

Yeah right.  You think Western CBs will re-price gold to 10k/oz and make India the richest country on earth?  Think again.  The beauty in the system is that it's just a pile a shit on top of another pile of shit.  SDRs will be used, not gold.  Just keep on piling the shit forever!

In reply to by Herdee

shizzledizzle Fri, 06/23/2017 - 09:09 Permalink

Sounds to me like they are trying to drum up folks for the other side of the trade. Until they actually start "Unwinding" or do a real rate hike (75 bps or more) it will be more of the same as usual.

Uncertain T Fri, 06/23/2017 - 09:28 Permalink

Pensions of all stripes are so deep into 'underfunded' that any drop in asset values will collapse everything.  So therefore, BTFD as the CB's will come to the rescue.... that is... until they don't. 

Money_for_Nothing Fri, 06/23/2017 - 10:19 Permalink

Here is BS from the past. Barely needs updating.

Economists disagree about the causes of this downturn.
Keynesian economists assign blame to cuts in federal spending and increases in taxes at the insistence of the US Treasury. Historian Robert C. Goldston also noted that two vital New Deal job programs, the Public Works Administration and Works Progress Administration, experienced drastic cuts in the budget which Roosevelt signed into law for the 1937-1938 fiscal year.

Monetarists, such as Milton Friedman, assign blame to the Federal Reserve's tightening of the money supply in 1936 and 1937.

Contrary to the monetarist assumption, Austrian School economist Johnathan Catalan assigns blame to the relatively large expansion of the money supply from 1933 to 1937. He also notes that the money supply did not tighten until after the recession began.

Russdiamon Fri, 06/23/2017 - 10:28 Permalink

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WolfgangCire Fri, 06/23/2017 - 12:26 Permalink

why would central banks be desperate? dilemma? they're stealing all they can as they collapse the old system to replace it with a digital system (cryptos) in order to finally control and enslave humanity. to start ww3, perhaps all they have to do now is shoot down a russian/syrian plane in syria. whos gonna stop the central banks from doing what they want? you?  are you gonna stop them? good. at least we have you. so maybe there is a chance. there sure is a shit ton of us normal people and just a few of those psychopaths. unfortunately, those psychopaths have the police and military - the whole system -  to proctect them. so i guess it boils down to russia and its allies being humanity's best hope. that is if theyre not in on it too.