BofA Predicted The Crash: Here's What It Thinks Happens Next

Last Friday, just before the market imploded on the higher than expected hourly earnings print, we published a Bank of America note titled "Our Sell Signal Was Triggered On Jan 30, S&P 2686 Is Next" in which chief investment strategist Michael Hartnett explained why he was convinced that a drop as much as 12% was imminent in the coming 3 months. He pointed to a proprietary bank indicator that - when triggered - had correctly predicted a drop that averaged 12% over the coming weeks. As a result, he said that his immediate target for the S&P was 2686.

With the S&P trading 100 points below his target just one week later, and 300 points below where it was just last Friday, we can now say that this indicator has been accurate on 12 out of 12 occasions.

However, if that was troubling, what Hartnett said today was even more concerning: in his latest Flow Show released on the same day as the record outflow from equity funds was revealed...

... Hartnett writes that after 706 rate cuts, $12.1tn asset purchases by central banks, global interest rates @ lowest levels in 5000 years, "2018 marks end of era of maximum liquidity, maximum asset returns, minimal rates, minimal volatility, minimal spreads…end of era of Wall St inflation thanks to Main St deflation."

He also reiterates what we - and Moody's - said earlier, namely that 2018 is the year when the US deficit exceeds $1 trillion, something which is clearly not lost on the 10Y yield, and in turn is prompting selloffs across equities every time the 10Y yield approaches 3%.

Which brings us back full circle back to Hartnett key 2018 BofAML themes:

  • big long = Volatility
  • big short = Credit
  • big top = Equities
  • big rotation = Deflation to Inflation
  • big risk = Equity Bubble


And with Hartnett's original correction warning is now in the history books, having been confirmed just days later, the BofA CIO warns that more of is coming, with "correction vulnerability" in 2018'Q1 high due to:

  • "Amazonification" of Main St (low inflation)
  • "Japanification" of Wall St (low rates)
  • "Icarus trade" (melt-up in risk assets)

These three have all became euphorically priced, e.g. China tech sector on 9x book (vs China financials on 9x earnings), European HY bond yields < US Treasury yields; VIX & MOVE at 50-year lows; global equity market cap +$30 trillion since Feb 11th 2016 lows.

The result is unfolding before our eyes, with daily 3-4% moves in the market, and nobody having any clue when the selling will stop.

Hartnett, however, has a clue what may be coming next: the reflationary year 1966, when rising rates caused a 16% drop in the S&P:

Structurally investors should study 2018 = 1966 analog…start of secular rise in inflation & interest rates caused S&P500 -16% in 1966, "Nifty 50-small cap value barbell" worked well  (Chart 6) until inflation surge in 1969 caused massive shift from equities & bonds into commodities & cash (Chart 7).

Once dust settles, BofA's CIO expects:

1. much greater differentiation in leadership of Tech;

2. rotation from Davos Man to Joe Six-Pack portfolio e.g. long RTY, short SOX;

3. leverage will no longer be in vogue.

* * *

In practical terms, here is how the correction will play out in chronological terms:

Correction chronology: XBT…UTIL…GT5…VIX…JNK…EMD…SPX; last Feb dominoes to fall should be DXY, CNY, SOX & EEM.

* * *

Hartnett also knows how the correction/crash will end: with central bank intervention, or as he puts it: "markets stop panicking when central banks start panicking"

late-cycle crash/correction in 1987, 1998, 2016 all arrested by policy actions; crucial to note Fed now hawkishly selling Treasuries (Chart 4) and rhetoric past few days shows Fed "buyer of vol" not "seller of vol" for 1st time since 1987

That said, two upcoming events could soften the Fed stance

  1. Jan CPI (Feb 14th) <0.3%mom;
  2. Humphrey-Hawkins (Feb' 28th) opportunity for Powell to signal old, cautious Fed back.

 

Hartnett has two more notable observations. 

First, how to know if this is a correction or a bear market? Look at the buybacks.

best sign corporations do not see profit peak is resumption of strong corporate buybacks in coming weeks; profits key determinant as to whether this is a correction or a bear market.

Putting this all together, Hartnett's reco is simple: use 2540 on the S&P and a 3% 10Y yield as "entry points in coming weeks."

 

Comments

MK ULTRA Alpha HRH of Aquitaine 2.0 Sat, 02/10/2018 - 02:17 Permalink

Thinking about the market's orderly sell off from a frothy peak, there were two much touted economic trends, inflation and the budget deficit.

Higher employment was being used to prove the inflation theory and economic metrics like the velocity of money increase was cited with a slight up tick. But that's not run away inflation.

MSM is hyping the budget deficit will be over a trillion. This is inaccurate data, the source data used are the auction banks, this is what they hope will be their market. It's hyped to around 25% higher, but there has been no accurate prediction of what the budget deficit will be from any reliable source.

These two risk inputs, inflation and budget deficit found there way into reasons for the market sell off. It was secondary and MSM overly hyped it and made up an economic scenario of doomed budget deficits and rampant inflation.

There won't be a trillion dollar deficit and inflation isn't rampant and out of control.

In reply to by HRH of Aquitaine 2.0

Singelguy MK ULTRA Alpha Sat, 02/10/2018 - 07:16 Permalink

I will take whatever you are smoking. Everyone here knows that the inflation numbers are cooked. You obviously haven’t been to a supermarket in the past year, otherwise real inflation would be obvious. Trillion dollar deficits are inevitable. As interest rates rise and confidence in the US dollar wanes, the interest expense on the existing $20 trillion debt will rise. The only way to avoid a trillion dollar deficit is to raise taxes or significantly reduce spending. 

In reply to by MK ULTRA Alpha

bigloser Singelguy Sat, 02/10/2018 - 08:51 Permalink

The entire inflation/deflation argument is, in my opinion, largely dependent upon who you are, where you live, what you buy, and personal spending habits.

Just for smiles, here's a little snapshot of some of my most recent purchases. I live in rural upstate NY, but there's still Wal-Mart, Lowe's, Dunkin Donuts, McD's, etc. around.

Yesterday, at Was-Mart: 6 donuts for $1. A loaf of bread: 35¢. These were from the "day-old" bin at the back of the store, a popular point for many.

Stopped by the local firewood dealer, loaded more than 1/2 face cord of firewood into my truck for $35. No tax.

A couple of months ago, I bought a 2006 Olds Alero (144k miles, new tires) for $400. Yes, that's four hundred dollar. I admit to being lucky, in the right place at the right time, but, the car needed all of $60 worth of repairs and I'm planning another $100 or so (muffler, trunk latch) and it's good to go.

My car insurance - now, I'm 64, haven't had an accident or ticket in more than 20 years - is $320/year.

I routinely buy food at very low prices, look for sales, and buy produce in summer from local farmers. Very reasonable.

Now, if you're a family guy, with kids, you're probably paying through the nose for everything from shoes, shirts, and underwear to sporting goods and remedial classes. Plus, property taxes aren't going down any time soon.

I understand full well that RE prices will come down with higher rates. I don't call that inflation.

In reply to by Singelguy

MK ULTRA Alpha Singelguy Sat, 02/10/2018 - 16:21 Permalink

I was talking rampant inflation growth like the early 80's. You took me out of context to feed your rant.

And I doubt the budget deficit will be a trillion.

The Fed is allowing parts of their balance sheet to mature, the Fed is making a profit, all profits must be turned over to the Treasury, that's what's been happening and that amount is growing. It is way too early to predict a trillion dollar budget deficit. But MSM is chanting the fake news trillion dollar deficit and you ran with it, trying to bring others into YOUR TV MIND CONTROL PSYCHOSIS.

And TV head, TV mind controlled victim, MSM was using a source which is always inaccurate and hyping the market in Treasury notes. They MAKE the market and have a vested interest in creating a larger market to attract more investors.

AND a major communication just for you're TV mind controlled mind, parroting, foaming like a rabid dog, parroting the only data, your brain has been told to function, it's absolutely all your mind has to operate on.

Listen, if you make $20,000 you can afford a mortgage of what? $30K, $40K? How much can you afford to pay on? It's the same for the federal government, the US makes $20 trillion GDP each year,  the debt is $20 trillion, the payment on the debt is taxes on the $20 trillion GDP economy.

The US isn't broke, isn't dying and can actually borrow much more without collapsing in the bankruptcy doom and gloom you're pumping, just because you want it to happen, imagine it to happen, and use it in your daily life to justify your insane rant, well it's not happening.

There is no rampant inflation, and there will not be a trillion dollar deficit.

In reply to by Singelguy

Simplifiedfrisbee mtl4 Fri, 02/09/2018 - 15:10 Permalink

The racist unpatriotic fascists of America. The legion of satanic filth. 

 

Everything is a conspiracy and Trump is exonerated of everything. 

 

You all thought the left was brainwashed. 

 

The Mercer and Murdoch propaganda machine is evident. 

 

Mentally regressed and cognitive complacent people are easy to deceive.

 

In reply to by mtl4

Simplifiedfrisbee Singelguy Sat, 02/10/2018 - 14:59 Permalink

You are beyond your league pal.

 

Off the rip, I know you’re an old bag of dirt. 

 

Second, YOU can’t tell me anything with regards to propaganda if you haven’t analyzed both sides. 

 

You’re simply a biased fan who loves getting his ass torn in half by Republican propaganda. 

 

You’re similar to hardened shower scum. All truth slips past you. You don’t know a good nor a bad thing when you see it. 

 

Satanic tool. 

In reply to by Singelguy

InnVestuhrr Ghost of PartysOver Fri, 02/09/2018 - 13:19 Permalink

Correct, and in the 10+ years that the doom porn profiteers have been hyping selling financial assets to instead buy their no-income shiny shit, I stayed invested in CEFs paying 8+% yields.

Compare the investment results of

(a) 10+ years owning no-income shiny shit

vs

(b) 10+ years owning CEFs paying 8+% yields per year = lots of real income that paid all my expenses PLUS savings every year

(Warning, that is an IQ test)

In reply to by Ghost of PartysOver

Winston Churchill IH8OBAMA Fri, 02/09/2018 - 12:57 Permalink

Ever since I've been here,6 years close enough.

There were no interest rate swaps in 1996.We have super leverage in those derivatives,

1000s to one.If they start unwinding, 1929 would be nothing in comparison.Weapons of mass financial destruction as

uncle warren says.A quadrillion  dollars of them.

We don't know what interest rates will trip them either,an ELA in financial markets.

Superior creditors to customer bank deposits.

I'm going to the bank AGAIN today, a bird in hand.....

In reply to by IH8OBAMA