Three days ago, Bank of America's Chief Investment Officer, Michael Hartnett, published not one but 15 answers to the one question most investors are asking: "how late in the business cycle are we?" As Hartnett summarized it, we are now so "long in the vermouth", the late-cycle is starting to get "tipsy", and presented the following as evidence:
- 2017: Bitcoin’s rip from $300 to $19,600 in 3 years made it the biggest bubble ever
- 2017: Da Vinci’s Salvator Mundi sold for $450mn (would take average American 7,500 years to earn)
- 2017: Argentina (8 defaults in 202 years) issued a (oversubscribed) 100-year sovereign bond
- 2017: European high yield bonds were priced as less risky than US Treasuries
- 2017: the market cap of Facebook (25k employees) exceeded that of India (1.3bn people)
- 2018: US, UK, German, Japanese unemployment rates are at multi-decade lows
- 2018: the global stock of negatively-yielding global debt remains >$10tn
- 2018: S&P 500 trailing price-to-earnings ratio >20X…a level exceeded in just 12 of past 120 years
- 2018: S&P 500 price-to-book ratio >3X…a level exceeded in just 5 of past 70 years
- 2018: US tax cuts of $1.5tn will coincide with US corporate bond issuance of $1.5tn and US equity buybacks of $0.9tn
- 2018: QE “winners” (REITs, credit, EM assets) have started to underperform QE “losers” (volatility, US$, commodities, cash)
- Aug 22nd, 2018: S&P500 bull market becomes longest of all-time
- Dec 2018: Fed will be 9 hikes into tightening cycle & G4 central bank liquidity will be contracting
- May 2019: global profits are forecast to be 1/3 higher than their prior 2008 peak (IBES $3.3tn vs $2.4tn)
- July 2019: the US economic expansion will become the longest since the Civil War
Hartnett, did not miss the opportunity to showcase some of his favorite charts, including the "3rd largest bubble of the past 40 years", i.e. e-Commerce...
... and the just as ominous chart showing that every Fed tightening cycle ends with an "event", a topic that was picked up yesterday also by Deutsche Bank's macro strategist, Alan Ruskin, who also took the opportunity to remind us that "Every Fed Tightening Cycle Creates A Crisis."
Looking at the chart above, Hartnett also writes that his strategy is stay defensive until an "event" or rise in unemployment causes Fed to pause.
It should therefore not come as a surprise that in his latest "Flow Show", Hartnett starts off by repeating his thesis that it is "very late cycle" amid a "tightening Fed", and as evidence he presents the latest asset returns, where the outperformance of commodities certainly suggests he has a point, to wit:
2018 returns scream Fed tightening & late-cycle": commodities 12%, US dollar 2%, stocks 2%, cash 1%, bonds -2%; annualized commodities on course for best year since 2002.
The spectacular commodity outperformance is shown below: on an annualized basis, the commodity return of 34% means that Jeff Gundlach's December 2017 call was spot on, and that this would be only the first time since 2002 that commodities were the top performing asset class.
Meanwhile, in light of the tightening in monetary conditions, the BofA CIO writes that neither US capitulation on China trade war nor dovish Fed minutes induced risk-on flows this week...$0.5bn out of equities, $1.5bn out of bonds, $0.1bn out of gold. In short: traders are starting to look very closely at this chart:
Hartnett further notes that the rise of Commodities may be just starting, as a result of more central bank hikes than cuts in 2018 "consistent with inflation > deflation flows," as shown in the chart below.
Indeed, this week's flows demonstrate this, as big inflows to resources ($0.6bn energy, $0.4bn materials):
note US now largest world energy producer & exporter, and GDP Q2/3 will be boosted by oil >$70...US rig count at 3-year highs, and energy capex >20% US capex.
Meanwhile, perhaps a more interesting observation - if at least until this morning's surge in the US TSY which has sent 10Y yields sliding back to 2.92% - is that the market is (was?) starting to get very worried about inflation/supply/funding and nowhere is this more obvious than in the return on the 10Y, whose 2018 annualized loss of -10% is the worst since the Great Depression (specifically -12.6% in 1931) while the annualized return on AAA IG bonds (-11%) worst on record.
Of course, the pain for Treasurys investors may not last much longer if there is indeed another deflationary European crisis, i.e., global risk-off event, which makes US paper the global safe haven once again. However, no matter what happens in the US, Hartnett is confident that EM cracks will widen:
"since Q1’16 China/EM/oil crash...inflows to EM stocks = $600bn, EM debt = $200bn, EM equity + debt = $800bn, almost doubling."
Meanwhile, confirming that investors are now boycotting Europe is that this was the 11th consecutive week of European equity outflow, amounting to $2.6 billion in the past 7 days.
But nowhere was the pain worse than in Italy: according to BofA there was a record week of redemptions from Italy-only funds (6% AUM) as the BTP-Bund spread finally spiked, in a move which we previewed all the way back in December, which however is to be expected in a market which has long ago lost the ability to discount the future.