Earlier this week, Goldman Sachs, whose market-timing calls leave much to be desired, declared that tech stocks are "not a bubble", and went so far as to predict that the secular increase in tech names could continue for decades, spawning vivid memories of Goldman's May 2008 prediction of $200 oil just months before the start of the second great depression, and before oil crashed more than $100/barrel, wiping out a generation of muppets.
However, it is now safe to say that with the exception of some truly naive individuals, virtually nobody believes Goldman any more, and thus Goldman's "all clear" may be just the top-tick so many had been waiting for.
One skeptic is Bank of America's Michael Hartnett who back in March, just as the tech sector suffered its first big rout of 2018, had the gall to tell the truth and observe that the "e-Commerce" sector, which consists of AMZN, NFLX, GOOG, TWTR, EBAY, FB, was now 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 - was set to become the largest bubble of all time over the next few months.
Hartnett followed up this this week by noting that while so far Tech stocks have seen record inflows as they have emerged as the "defensive growth" sector of the late market cycle...
... the "big risk" is "as in 1998, that credit tremors spread and investors forced to deleverage from risk assets, raise cash", while the "biggest risk" is a "quick, deep tech selloff. Or, as Bloomberg's Andrew Cinko put it on Friday it, "if the times get tough and investors must delever they will sell "what they own," and that "those who are rotating to financials and banks this week and away from tech may simply be trading the frying pan for the fire."
Then it was the turn of Leuthold Group's Jim Paulsen who echoed Hartnett, and also pointed out that tech ETFs now account for 30% of trailing 2 year net fund flows, which was the biggest since - you guessed it - the dot-com bubble. Paulsen, who traditionally has had a cheerful, bullish take on markets, even went so far as to slam FANGs as the de facto harbinger of the next tech bubble:
"Haven’t we seen this movie before? Technology takes over the stock market late in a recovery cycle, seemingly making the bull ageless, pushing portfolios toward a more concentrated new-era exposure, stimulating investor greed bolstered daily by watching a chosen few (FANGs) rise to new heights, and convincing many that tech is really a defensive investment against late-cycle pressures which trouble other investments."
Now, with the rest of the world relaxing ahead of what has been called the "most important week of the year", in its Sunday Start "what's next in global macro" note, Morgan Stanley's Chief US Equity Strategist Michael Wilson, makes it a trifecta of urgent warnings about the tech bubble (sorry Goldman), which Wilson says could face its moment of truth "at any moment, and without warning."
Wilson's note begins with an anecdote about "lions, tigers and bears" and highlights that while 2018 financial markets look much different than they did in 2017, there are many stories to be told depending on which asset class you are talking about.
Starting with the broadest equity market, the MSCI All Country World Index, we have basically experienced a flattish year, oscillating both above and below the zero line several times. Similarly, global bonds, as measured by the Barclays Global Aggregate, have also been wrestling like a Lion with positive and negative returns for the year.
However, looking at narrower markets, we see a very different picture: US tech stocks, for example, continue to be absolute Tigers – the S&P 500 tech sector is up over 14% year to date, with 1/3 of its constituents up at least 20%. Meanwhile, US consumer staples stocks are down more than 13%.
We are spotting some real Bears, too, with Argentina and Turkey down close to 30% in US dollars.
Wilson also notes that at the single stock level, we have also experienced more pain than normal: take the S&P500 which is up close to 4% year to date, and yet a third, or 148 of the 500 stocks have seen a correction of 20% or more since valuations peaked on December 18. In the meantime, credit has traded sloppily this year, while being long rates has generally been a money loser.
In short, Wilson focuses on the divergence between the tech sector and virtually everything else, and notes that "that is exactly the “Tricky Handoff” we outlined in our 2018 Outlook. That handoff is the result of what we expect will be peaking earnings and economic growth this year, combined with rising inflation and tighter financial conditions as central bankers do their jobs." We highlighted the transition in question last weekend in a post discussing why even Bank of America has thrown in the towel on the coordinated growth narrative.
What makes the current phase in the tightening cycle especially precarious is that unlike prior occasions when financial markets wobbled, it’s unlikely the Fed can back off its planned tightening campaign as the economy is now overshooting the Fed’s dual mandate of full employment and 2% inflation, according to Wilson. Even the Fed’s self-imposed third mandate of financial stability is well within its bounds.
This, to Morgan Stanley, means "it might take a larger financial accident to get the Fed to change direction or even pause than in the past." It also explains why Bank of America is increasingly more cautious when it comes to risk and why the bank's CIO said that "we remain defensive & happy to sell risk assets into strength until the Fed forced to pause."
And, to be sure, flattish equity and bond markets hardly qualify as a "larger financial accident" even if there’s more dramatic pain in narrower asset classes. Meanwhile, MS notes that the ECB is sounding more hawkish at the margin with its desire to signal the end of QE by year-end at its upcoming meeting.
So absent a market crash, Michael Wilson concludes that we "are likely to continue experiencing rolling bear markets across asset classes, individual securities, sectors, and regions."
Specifically, with the acceleration of the Fed's tightening campaign, which moved into high gear in earnest in 4Q17 when the unwind of the balance sheet started and will peak in October 2018 – a clear regime shift – we have been experiencing “pop-up” thunderstorms in what Wilson calls "the weakest links" in the capital markets, starting in December with perhaps the most speculative asset class of all, cryptocurrencies. They were followed by Libor-OIS spreads, front-end funding markets, volatility-targeting strategies, European bank stocks, emerging markets (led by Argentina, Turkey and Brazil), and most recently Italian bonds.
Paradoxically, these dislocations have resulted in an even greater tech bubble, leading to "even more crowded positioning in what investors deem to be defensive assets – some of which may not prove to be as defensive as expected." Here Wilson is talking about growth stocks in general and tech stocks in particular. For those confused, his confusion should make perfect sense:
In a world where traditional defensive assets – high quality bonds, and utilities, telecom, healthcare, and consumer staples stocks – may not act as defensively as they normally do because they were bid up so high during the era of quantitative easing, investors have flocked to assets that can grow in any environment.
That would be growth stocks, and yet as Jim Paulsen notes above, there is nothing particularly new about what is going on: "technology takes over the stock market late in a recovery cycle, seemingly making the bull ageless, pushing portfolios toward a more concentrated new-era exposure, stimulating investor greed bolstered daily by watching a chosen few (FANGs) rise to new heights, and convincing many that tech is really a defensive investment against late-cycle pressures which trouble other investments."
Paulson did not predict how this would all end, but did post a rhetorical question: "haven't we seen this movie before?"
Indeed we have, yet as Wilson chimes in, the steady performance of these assets has only reinforced the perception that they are defensive. And here comes the warnings: according to the MS chief equity strategist, "the real risk may lie in the fact that what started out as an entirely reasonable theme may have run too far."
So when does this latest asset bubble burst? Here is Morgan Stanley's conclusion:
... it’s impossible to predict when the moment of truth will come. However, with financial conditions likely to continue tightening, it could be at any moment, and without warning. While I’m not yet forecasting a hard rain for these assets yet, I did see some raindrops on the Yellow Brick Road late last week. In the meantime, enjoy your Sunday.
And with all that said, the surest indicator that it's almost over for tech stocks, is Goldman's sincere promise to
muppets clients that technology is not a bubble: it means that Goldman is now actively dumping its entire prop and flow tech exposure to anyone gullible enough to believe it.