In recent weeks, Bank of America's strategists have turned decidedly gloomy on the market and the economy, warning on one hand that Europe simply can not be allowed to enter a recession as some €800BN in BBB-rated debt risks becoming a "falling angel" and flooding the junk bond market, while at the same time also warning that the global liquidity ushered in by QE has already turned negative.
Now, in the latest "scare piece" by the bank's Chief Investment Strategist, Michael Hartnett - who correctly predicted the February market tumble to the dot - puts together all the recent events that have troubled markets, namely: Fed tightening, US decoupling, flattening yield curve, collapsing EM, outperforming levered quant funds, and says that these are "all echoes of 20 years ago."
He is, of course, referring to the 1998 Asia/LTCM crisis, which he defines as a perfect example late-cycle global credit event inducing deleveraging/crash. Here, according to Martin, is how it unfolded:
And the one catalyst behind Hartnett's troubling comparison is the collapse in EMs, which as we noted earlier, just suffered a near record outflow, a harbinger of even more weakness for the sector.
As a reminder this is what happened "then", from BofA:
Between July’97 & Oct’98 EM equities fell 59% in US dollar terms. And in space of 40-60 trading days between July & Oct 1998…
- Stocks collapsed: SPX -22%, Nasdaq -33%, US banks -43%
- Japanese yen surged: from JPY147 to JPY112
- Volatility surged: MOVE index up from 60 to 200, VIX from 16 to 50
And, as noted above, to Hartnett the "2018 Fed tightening, US decoupling (Table 2) & dollar strength, flattening yield curve, collapsing EM, outperforming levered quant funds…all echoes of 20 years ago"
To be sure, we're not there just yet, even though as many have noted, it has been a painful year for most investors, who have not made any money in 2018...
Here according to BofA is what to watch in 2018 for a repeat of 1998?
- Vicious credit contagion/spread widening: e.g. EM bond spreads (EMGB) >400bps…EU HY spreads (HE00) >700bps…US HY spreads (H0A0) >500bps
- Further pressure on CNY >6.8 & HK dollar peg
- Interest rate insensitivity: falling bond yields fail to revive risk assets, with bank stocks in particular coming under pressure, e.g. BKX <95
- Yield curve “bull steepens” as markets beg for Fed pause in rate hikes…US dollar falls, WTI back to $60/bbl as global growth expectations weaken
There is a silver lining: if we indeed have an LTCM/Asia Crisis-style meltdown, Hartnett predicts that ultimately central banks will panic (as in 1998 or 1987 or 1994 or 2016 or 2011) and create a violent bear market rally in distressed assets. Today that’s EM & European markets, note German bank stocks close to 30-year lows, largely thanks to Deutsche Bank which not only failed the Fed's stress test but is in danger of getting kicked out of the Stoxx 50...
... leading eventually to the big outcome of the 1998 policy panic: the ’99 Tech bubble.