BofA's Apocalyptic Forecast: Stocks Flash Crash, Bond Bubble Bursts In H1 2018, War May Follow

Having predicted back in July that the "most dangerous moment for markets will come in 3 or 4 months", i.e., now, BofA's Michael Hartnett was - in retrospect - wrong (unless of course the S&P plunges in the next few days). However, having stuck to his underlying logic - which was as sound then as it is now - Hartnett has not given up on his "bad cop" forecast (not to be mistaken with the S&P target to be unveiled shortly by BofA's equity team and which will probably be around 2,800), and in a note released overnight, the Chief Investment Strategist not only once again dares to time his market peak forecast, which he now thinks will take place in the first half of 2018, but goes so far as to predict that there will be a flash crash "a la 1987/1994/1998" in just a few months.

Contrasting his preview of 2018 with the almost concluded 2017, Hartnett sets the sour mood with his very first words, stating that he believes "2018 risk asset catalysts are much less bullish than in 2017" for the simple reason that the bearish positioning going into 2017 has been completely flipped: "positioning now long, not short; profit expectations high, not low; policy close to max stimulus; peak positioning, peak profits, peak policy stimulus means peak asset returns in 2018."  He also goes on to point out that the historical omens are poor:

  • Bull market in S&P500 would become the longest ever on August 22, 2018 (and the second biggest ever at 2863 on S&P500).
  • Equities have only outperformed bonds for seven consecutive years on three occasions in the past 220 years (the last time was 1928 - Chart 1).

Having read Hartnett for many years, we can sense an almost tangible undertone of anger and frustration at central banks for making his bearish forecasts for 2 years in a row go up in a puff of smoke. Which probably explains why one of BofA's best strategists has decided to double down, and raise the stakes beyond a simple market crash, and to a flash crash, if only for dramatic impact.

But before we get there, here is Hartnett's explanation why the market will peak in the first half of 2018:

The Big H1 Top

We forecast a H1 top in risk assets as the last vestiges of QE, the passage of US tax reform and robust early year EPS revisions incite full investor capitulation into risk assets. Potential targets are SPX 2863, CCMP 8000, with US government bond yields moving >2.75%.


We start 2018 with a pro-risk asset allocation of equities>bonds, EAFE>US, gold>oil, bullish US dollar.


We believe the air in risk assets is getting thinner and thinner, but the Big Top in price is still ahead of us. We will downgrade risk aggressively once we see excess positioning, profits and policy.


Peak positioning would be signaled by…

  • BofAML Bull & Bear Indicator exceeds “sell signal” of 8 (Chart 2);
  • Active mutual equity funds start to see inflows;
  • BofAML GWIM equity allocation exceeds 63%, an all-time high (currently 61%).

How to know if/when peak profits arrived?

US ISM dips below 55: needs to end 2018 >55 to beat consensus global EPS estimate of 10.5% (Chart 3); Inverted yield curve, which in seven out of seven occasions in the last 50 years has been the prelude to recession.



More to the point, how to know that peak central bank policy has arrived?

  • Q2 peak in G4 central bank liquidity of $15.3tn: net central bank buying of financial assets drops from $1.5tn in 2016 and $2.0tn in 2017 to nearly zero in 2018;
  • US tax reform passed, after which investors must discount tighter, not earlier economic policies.

Which brings us to Bank of America's "big long" trade: volatility, and the stark prediction that in just a few months, a 1987-type flash crash which will wipe out trillions in market cap, is imminent.

The Big Long: volatility


Second, we believe that peak positioning, profits, and policy in 2018 will engender peak asset price returns and trough volatility. In 2017, stock market volatility fell to 50-year lows, bond volatility fell to 30-year lows, ETFs accounted for 70% of daily average global equity volume, the AUM of quant hedge funds is now $432bn (up $271bn since 2009).


A flash crash (à la ’87/’94/’98) in H1 2018 seems quite likely, in our view, as the major sedative of volatility, the central banks, start to withdraw liquidity.

According to Hartnett, the right way to to trade the upcoming flash cash and the "Big Long is throguh a combination of  long 2yr/short 10yr Treasuries, long TIPS steepener vs flattener in OATei, long SPX put ratio calendar, long Russian equities.

As an added "bonus", in addition to a "big long", the BofA strategist also has a "big short" trade, which perhaps not surprisingly, is in credit.

The Big Short: credit


Third, we believe that higher inflation, higher corporate debt levels, higher bond volatility and the end of the QE era will be most damaging for corporate bonds.


The big 3 consensus assumptions are: Goldilocks, no Fear of Fed/ECB, and no Mean Reversion. The game-changer is wage inflation, which on our forecasts is likely to become more visible. Wage inflation would shatter consensus via higher credit spreads. 3½% US wage growth, 2½% US CPI, and 2% Eurozone CPI are all inflation levels likely to increase volatility and credit spreads.

For those looking to trade in advance of the bursting of the credit bubble, BofA's advice: go long CDX HY & iTraxx XOVER.

* * *

Finally, if that wasn't bad enough, in addition to the combined bursting of the short-vol and long credit bubbles, BofA has one final prophecy: "the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside." Here's why:

The Big Risk: tech bubble


Finally, we believe the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside. The era of excess liquidity, bond yields fall, and the Nasdaq goes exponential. 2018 calls for the big top, big volatility long, big credit short, all once again prove to be way too early. An “Icarus unleashed” bubble nonetheless could end in 2019 with a bear market on hostile Fed hiking, Occupy Silicon Valley and War on Inequality politics.

Translation: the Fed - having created the record wealth, income and class divide that resulted in Brexit, Trump and a wave of nationalism across Europe - is unable to stop, and unleashes civil, and perhaps world war as its final act.

How to hedge against "the biggest risk of all"? Hartnett has two words of advice: buy gold.


SoDamnMad J S Bach Tue, 11/21/2017 - 05:57 Permalink

Already has.  The thirst for profits from Qatar gas and future Israeli gas through Syria has set up the players for a full blown conflict in the ME. Iran-Hezbollah in Lebanon attacked by KSA/ Israel will ramp up. Strait of Hurmoz blocked with a couple VLCC sunk then oil to spike crushing economies outside the war zone.  Escalation with US-Russia-China having their hands on the "button". Pray to you god.

In reply to by J S Bach

seattleslewsz Mon, 11/20/2017 - 16:10 Permalink

 Bank america more wild specualation.  right one day maybe. traders on here who are making money will stick with the analysts who have been right for  decade of ups and downz   SHEPWAVE!

Let it Go Mon, 11/20/2017 - 18:29 Permalink

Time has a way of revealing certain realities but does so at its own choosing. The economy is far from a well-oiled and designed machine and in the end, we may find that it is not really completely under the control of those who have been placed in the driver's seat.In a world where central banks have become so deeply involved in manipulating and distorting markets we find true price discovery no longer exist. The question remains how best to prepare for a economic meltdown. Expect both luck and caution to play a big role on our individual fortunes as we move through the financially violent period before us. More on this subject below. http://The Catalyst Of Our Economic Demise has Yet To Be Determined .html

Let it Go Mon, 11/20/2017 - 18:37 Permalink

Never before do I remember seeing so many predictions of interest rates remaining low forever and a day. Many of us have a problem lending hard earned money out for a long period of time and we should be wary of bonds.

Cassandra.Hermes Mon, 11/20/2017 - 19:01 Permalink

I have trimmed my company. I have let go of all Trump supporters, not because they are dangerous for humanity but because they were the worst performers and because they were browsing internet more than the rest.

canisdirus Tue, 11/21/2017 - 00:23 Permalink

"Buy gold"

Is this guy insane? We are currently in the middle of the biggest asset bubble in human history. If anything, buy non-perishable food or high quality tools. When this all goes down, the people young enough to work with practical skills and the few with productive physical assets (think equipment to make things we have outsourced to Asia) will be in the best positions.

Yen Cross Tue, 11/21/2017 - 02:02 Permalink

 I have an old ZO-6 Corvette.  When I get pissed off, I drive it over the pass to Palm Springs. If I live, I keep trading. A buddy of mine,taught  me this technique. The crazy bastard was always on a "Death Wish".   Litterally doing 120-130 mph in the dark ,controled slides over Cahon Pass. What doesn't kill you, makes you stronger!  Bitchez

besnook Tue, 11/21/2017 - 02:22 Permalink

economic forecasting is terrible with real data. fake data and manipulated markets make predicting markets impossible. there will be a flash crash but along the lines of 9/11, as in, there will be false flag to settle israel's issues in the mideast and ending the rapidly increasing dominance of the china/russia helix. the zionazis are very predictable on the other hand.

wonger Tue, 11/21/2017 - 04:43 Permalink

So they are now saying, dont worry and fill your boots as all will be fine until later next year, hmm what about if the market has already topped out! lolShort and staying short spx adding on every rally

JBPeebles Tue, 11/21/2017 - 15:01 Permalink

Everybody wants to know what will happen. ZHers being generally decent people, they have a right to know!First, there will be a crash. It'll be fast and probably over in a second. Those who've read Michael Lewis' book on High Frequency Trading know how it'll go down: a huge notational dump that trip the algos as a sell/short signal. Seeing the prices swing, other algos will pile on, accelerating the volatility. Once the volatility balloons, that will kill off the vol shorts and vol will go higher fast.The effect of all these derivatives will be accelerated selling of the derivatives which will increase shorts and spiral the price down even further.We know the system is vulnerable to the absence of liquidity. Credit doesn't have to be finite but someone needs to come up with the actual money so counterparty risk is a major risk accelerant.In other words, the chance that somebody on the other side of the trade doesn't actually have what they say they have grows exponentially in a crisis. This discourages buyers who don't know just where the prices will bottom and don't want to buy possible garbage.Enter the Federal Reserve. They replace the financial responsibilities of key players in the system. This is done in the name of stability but we know it introduces moral hazard--the likelihood that those who expect a bailout (nearly free liquidity in infinite quantity) behave badly and therefore grow the risk of default or managerial misconduct with their funds.The Fed has institutionalized the easy money through the discount lending window and other efforts meant to increase access to liquidity for the chosen few. During the '08-9 crisis and since, they've bought vast sums of inferior quality debt from the financial entities who would grow broke if those assets were marked to market. In general the market for securities like those bought by the Fed is limited, and lacks sufficient transparency and GAAP-level accounting standards that are meant to standardize marketable debt securities for the purposes of exchange and sale.Well, the Fed acts on behalf of the banks so we know a crisis can only happen without their involvement. If the Fed backstops the TBTF banks which will act badly, then the market risk can be reduced. Yet the underlying problem is the willingness of the Fed to intervene. They would no doubt treat any market crisis as an excuse to intervene.Like '08-9, they'll balloon their balance sheet, absorb the debt securities of rapidly declining value, and stabilize the equity and bond markets by showering them in endless amounts of free money, or liquidity.So a crisis may not come from Fed intervention but rather the absence of it. As long as synthetic demand can be produced by the Fed, artificially high valuations can be sustained. Don't see a risk with Trump and Powell raising rates (which is brought about by not buying debt offering lower rates.)The liquidity trap breeds major problems with pensions which is a tax problem due to low projected rates of return. This is a major bleed, more a slow decline than a sudden knockout. Getting out of the low rates gets harder and harder, leaving us like a buffalo at a Yellowstone geyser who struggles to get out of hot water and freezes as it tries. It can go back in and rewarm itself and eventually starve or it can try to getout and freeze in the process--those are the only two choices.