BofA: The Liquidity Supernova Is Ending, "This Is The Biggest Risk of All"

If 2017 has had a surreal feel to it, it is because it has so far been a "perfect encapsulation of 8-year QE-led bull market" according to BofA's chief investment strategist Michael Hartnett, a "bull market" which has turned financial logic and fundamental economic relationships on their head, and replaced everything with copious money creation as the only marginal price setter.

What are the characteristics of this "bull market": Hartnett describes them as i) Lower-than-expected rates, ii) higher-than-expected EPS, iii) non-existent inflation = big cyclical returns for asset prices (e.g., EAFE equities & industrial metals); but thematic leadership of “scarce growth” (e.g., tech stocks) & “scarce yield” (high yield and EM debt) which remains the heart of the bull.

In order to spawn and rear this artificial bull market, central banks have unleashed an unprecedented degree of extraordinary monetary easing in recent years, revealed by lowest interest rates in 5,000 years. As BofA further calculates, we have seen 698 global interest rate cuts since Lehman bankruptcy, as well as $11.1 trillion purchases of financial assets by central banks since Lehman.

However, if it was central bankers' intention to boost Main Street at the expense of Wall Street, they failed - as we warned would happen in 2009 - and as everyone now realizes. They did succeed, however, in created the biggest Wall Street boom in history: since the Global Financial Crisis ended in 2009, US equity market cap has risen $17.8tn…far, far outpacing the $2.6tn gain in US real personal income

However, like every other artifical, man-made thing, this "bull market" too, will come to an end. Here, the structural reasons are three, and all go contrary to what the inflation that the Fed is desperate to spawn: these are Debt, Demographics, and Disruption, and combined result in Deflation.

According to Hartnett, who first coined the equality, the 3 “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cap inflation: "the slowdown in the growth of the working population is deflationary, as are new biotechnologies that may extend human life"

Here, BofA also points out that technological disruption is also deflationary via an increased supply of labor, energy, services, financial, consumer products. Furthermore, the number of global robots by 2020 is expected to rise to 2.5 million, up from 1 million in 2010. According to the bank, US urban workforces most at risk of automation are in the Midwest, Florida, south California; less at risk in San Francisco, Seattle, Boston, NY,

The combination of record debt, record deflation and record (old) demographics means that deflation assets have massively outperformed inflation assets at the same time as US equities have massively outperformed non-US equities.

This euphoria, in turns, leads to one bubble after another.

According to Hartnett, the structural risk is that the era of excess Liquidity & wage Disruption by AI ends with a tech & credit bubble, one which will force the Fed to pop it - this is Jay Powell's "biggest nightmare." But before he does, the 30-year UST would go to 2%, according to Hartnett, while HY spreads would drop to 100bps and the Nasdaq would hit 10,000.

Yet as the world careens to this final, mega bubble burst, the liquidity supernova is already ending.

Yet while the market is aware of this, what it does not believe is that the one thing that can stop the party - inflation - will appear. Indeed, according to Bank of America, inflation is the single biggest risk for asset prices in 2018.

In this context, Hartnett calls 2018 a "one-decision market" : either inflation returns (bearish) or it doesn’t (bullish):

 risks to “Goldilocks” consensus: 1. “inflationary boom” = rates up = flash crash a la 1987/94/98…best trade = long CRB, short CCMP; 2. “recession” via Quantitative Tightening + lower EPS = bear market…best trade…long T-Bills & gold, short HY & EAFE.

Hartnett concludes by looking at the fate of the "Icarus Rally" which he first defined one year ago, and says that "the only reason to be bearish is there is no reason to bearish."

But even that, almost a decade into the most insane market period in history, is coming to an end:


Ghost of PartysOver 38BWD22 Fri, 11/03/2017 - 14:38 Permalink

Like many others including myself buying PM's may have been premature.  In the end it may be the best investment decision I ever made.  Until then keep playing the paper game (stocks) to fund the PM's.  The only way, as I see it, that the Dollar Dependency craters is when other countries go back to the gold standard.  It would appear as of today that may be China and Russia goal.

In reply to by 38BWD22

Ghordius TedFarr Sat, 11/04/2017 - 07:33 Permalink

"I'm almost all in PM's. In 10 years will I be a genius or a moron?"wrong way to put it, imho. try sorting out outcomes, firstin the best possible outcome you live a long, prosperous life where your precious metals pass to the next generation, untouched, and may pass to many more to comein the worst possible outcome you were a genius... but it was all for noughtor can you imagine a better or a worse scenario? that's my two champions

In reply to by TedFarr

Ghordius hotrod Sat, 11/04/2017 - 07:43 Permalink

"Yes but the Euro, Dollar and Yen represent 90% of usa trade and collude to protect each other"so your theory is that there is a Currency Peace, or a Currency Alliance, instead of a Currency Warfirst: the dollar was, once, more in an alliance with european currencies. an alliance that was ended by Nixon on August 15th, 1971second: arguably the biggest monetary ally of the dollar, lately, was the People's Bank of China. by buying trillions of US Treasuriesthird: most fiat currency dealers have to protect business in their area first and above all. from local price issues to trade and so foreign exchange. why? well, they have to protect the interests of those who put them there in the first place. no American has a voice in selecting the chief of the People's Bank of China, no european has a voice in selecting the Japanese currency chief, no Japanese has a voice in selecting the FED chairman, and so on. it's Russians that select the currency dealer that trades the Russian Ruble, etc.

In reply to by hotrod

Winston Churchill Ghost of PartysOver Fri, 11/03/2017 - 16:19 Permalink

That will be explained to Trump in Peking,as a choice, and a last chance.Stop all warmongering, and join the OBOR system in peace ,or be crushed economically.Choose wisely Donald.Much as I'd like $50k gold,living in 3rd world conditions is not forold men.I could do it,did do it when young, but the sanitation diseases are hard onany body,let alone an old one.If you think it couldn't happen here, you're wrong.Karma is a bitch.

In reply to by Ghost of PartysOver

lasvegaspersona RawPawg Fri, 11/03/2017 - 14:45 Permalink

sooooo...all these CBs will drastically stop doing what they have been doing fo 9 years?.....or....are they just saying they can quit any time?.....I remind myself how good hyperinflation feels at first and how painful deflation feels....Some how I think they will continue to do what they are doing until something breaks.

In reply to by RawPawg

BurningBetty Fri, 11/03/2017 - 15:22 Permalink

See, if you look at this from another point of view you can come to the conclusion that the Central Bankers and planners got one important thing figured out:- that the sheep are willing to work for the same money they are printing and they are not revolting! It's one of those EUREKA moments where you realize you can do this forever, propping up the stock market and giving your buddies free access to this cash by proping up their portfolios, while the sheep who hardly own any equities will keep financing their(our) own slavery! Best F plan ever!

Milton Keynes Fri, 11/03/2017 - 15:22 Permalink

The issue of money supply in a deflationary, depressionary market is relatively unknown to economists. Japan has been in a liquidity trap for a generation with minimal signs of inflation. Despite massive stimulus, Massive deficit spending,the deflationary pressures are causing a downward spiral. It could be this phenomena is now global.

LawsofPhysics Milton Keynes Fri, 11/03/2017 - 15:50 Permalink

Exactly, of course what they are counting as "inflation" is fucking bogus. The Fed's actions alone have in fact created 16X more paper/digital claims...The real cost of living at a decent standard of living continues to go up up up...Yes, it is now a global race to the bottom, in other words Global Weimar, as more and more people retire around the globe all those claims will start seeking out real assets.

In reply to by Milton Keynes

gdpetti Fri, 11/03/2017 - 19:05 Permalink

Those charts didn't add in the crypto bubble which is growing faster than the others... which is why some of the data currently looks 'less bad' as some previous bubbles.... same with the derivatives which are hard to keep track of and hard to place in this bubble charting... which again, make the current one seem less 'bad' as others.... which had more 'open' or obvious lines of sight.