In a report that explains the recent market volatility as having nothing to do with Trump-induced nausea and everything to do with the Fed ("We believe the simple reason that risk assets are struggling in 2018 is the Fed. Investors have been forced to acknowledge a tightening cycle is well underway"), BofA's Michael Hartnett moves away from listing the latest tactical and cyclical market drivers which we covered earlier, and lays out what the Chief Investment Strategist thinks are the three big secular trends threatening investors in 2018.
These are as follows:
- Regime shift from Quantitative Easing to Quantitative Tightening
- War on Inequality trade, immigration & redistribution policies
- Occupy Silicon Valley policies
Combining these, the result over the next few months could be nothing short than the second bursting of the tech - or technically e-commerce - bubble.
Recall that two weeks ago, we first showed that according to BofA, we are now witnessing the third biggest bubble in history created by a central bank. As Hartnett wrote, "the lowest interest rates in 5,000 years have guaranteed a melt-up trade in risk assets", which Hartnett has called the Icarus Trade since late 2015, and points out that the latest, "e-Commerce" bubble, which consists of AMZN, NFLX, GOOG, TWTR, EBAY, FB, is up 617% since the financial crisis, making it the 3rd largest bubble of the past 40 years, and at this rate - assuming no major drop in the 6 constituent stocks - the e-Commerce bubble is set to become the largest bubble of all time over the next few months."
The problem is that lasting even a few months with a "major drop" in the e-commerce bubble may prove very problematic, largely due to what Hartnett calls "Occupy Silicon Valley", which he explains as follows:
The economic & social disruption of technology is unlikely to stop. It has many beneficial economic & social impacts. But the sector’s growth, power & visibility make it extremely vulnerable to increased regulation & taxation, most especially if recession wrecks government finances.
Which brings us to the core of Hartnett's latest research note: "10 reasons why global investors should reduce tech allocations in 2018" which are as follows:
- 1. Excess returns & fancy valuations: US tech is best performing sector in QE era, up annualized 20%; ex tech the S&P500 would be 2000 not 2600 today
- 2. Bubbly prices: US internet commerce stocks (DJECOM) soared 624% in 7 years at their peak, 3rd largest bubble of past 40 years (see chart above)
- 3. Fat market caps: US tech market cap ($6.4tn) exceeds that of Eurozone ($5.0tn); FAAMG+BAT market cap of $4.9tn exceeds Emerging Markets ($4.6tn).
- 4. Earnings hubris: tech & eCom companies currently account for almost 1/4 of US EPS (Chart 6); this level that is rarely exceeded, and often associated with bubble peaks; note there are currently just 5 “sells” out of 250 FAAMG recommendations
- 5. Politics: privacy becoming policy issue as equivalent to entire global population searches Google every 2 days; last year 1579 “data breaches” exposed 179 million records of personal names plus financial or medical data; pending US & EU regulation threaten 4% of tech revenue.
- 6. Wage disruption: IMF says 50% of the decline in labor’s share of income is attributable to technology (25% due to globalization); number of global industrial robots by 2020 will be 3.1 million (was 1 million in 2010)
- 7. Tech is cash-rich, tax-light: sector has $740bn of cash overseas (larger than all other sectors put together ($510bn); effective rate of tax on US tech companies is 16.9%, lower than the 19.3% paid across the S&P500
- 8. Tech most lightly regulated sector: just 27K regulations (Chart 7) for tech; by comparison manufacturing regulated by 215K rules, financial sector by 128K.
- 9. Tech & trade: US tech has highest foreign sales exposure (58%) of all US sectors
- 10. Occupy Silicon Valley: tobacco (1992), financial (2010), biotech (2015) industries illustrate how waves of regulation can lead to investment underperformance.
Finally, putting it all together, is this chart which suggests that it is only a matter of time before the government bursts the third biggest bubble ever created by central banks.