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.