BofA: The Market Is At A Critical Junction Where A Trade War Could Lead To A 40% Crash

One month ago, and well before the latest market swings and turmoil, bank of America joined the chorus of "late cycle" warnings, writing that its proprietary "Global Wave" indicator just peaked for only the tenth time in 25 years, noting that in the last month, five of the seven components deteriorated including confidence, market, and real economy indicators.

Commenting on the implications of this inflection point, BofA said that a peak in the Global Wave tends to come with a period of more mediocre returns in equity markets but noted that sustained negative returns are only evident in those episodes that lead to global recession. In the global recessions of 2000 and 2007, the peak in the Global Wave was very close to the peak for the global equity market. Sharply negative returns followed (averaging -14% after six months and -36% after a year).

So what are the consequences for markets? Well, there are good and bad news.

The good news is, or rather would be, if the current global wave peak is not like the peaks observed in 2000 and 2007, in other words if what follows is not a recession. Here is BofA:

Ex of recessions Global Wave peaks point to a pause not end of equity rallies: Stripping out those two recession periods, the average profile for MSCI ACWI shows a market that moves sideways for 6-12 months around the peak in GW. In 2018, we are so far tracking reasonably closely to that pattern, with global equities trading in a range since the correction from the January highs. The typical profile then suggests a bias to the upside six months subsequent to the peak in the Global Wave. 12 months after the non-recessionary peaks MSCI ACWI was on average 11.6% higher.

That said, the average non-recessionary post-peak profile masks a wide range in outcomes historically. As BofA admits, material drawdowns were not uncommon in the non-recession episodes. Notably there were sizable (20% plus) corrections in 1998, 2002, 2011 and 2015. 2002 was really the continuation of the post TMT-bubble bear market so is very different to the other observations or indeed the current episode which all saw strong returns in the preceding 12 months. Additionally, two of the other three episodes were associated with stress in EM (1998 and 2015), while 2011 was centered on the European sovereign debt crisis.  Nevertheless, as shown in the chart below, global equities were 10-20% higher 12 months after the peak in Global Wave in five of seven non-recessionary episodes.

 

Obviously, this implies that the "bad news" is if we are currently trading through a 2000/2007 scenario, because as the next chart shows, in those two scenarios, the average global market return 12 months after the peak was hit, are a chilling -36%: a crash of such a magnitude in the current environment - without central bank intervention - would unleash a global recession, if not depression.

And most importantly, the next overlay chart which compares the current pre/post peak inflection point to all the prior ones, suggests that there are two possible outcomes of what happens next: markets either "shrug it off", and proceed to rise another 10%, as they did across all historical episodes except 2000 and 2007, or they crash as they did in those two years.

Here, BofA also notes that some notable parallels exist in the current market backdrop to other, more turbulent prior episodes: monetary policy is becoming less accommodative as was the case in the early or intermediate-stage Fed tightening cycles in 1995, 1998 and 2005. Volatility and some instances of financial stress are found in EM, which was also a feature in 1995, 1998 and 2015.

The question, therefore, is what will determine which of two paths the markets take?

And the answer, according to Bank of America, is simple: "whether we get a trade war or not."

We see two potential paths for markets. The first is where there a full-blown trade war which damages global growth and markets have to correct significantly to adjust for lower profits. The second is where a full-blow trade war is averted (albeit after some initial skirmishes) and markets return to focus on a decent growth and earnings backdrop and equity markets spike sharply higher.

This simple "binomial tree" will impact all asset classes:

  • Bond markets are likely to take the opposite side of this with a full blown trade war likely to force central banks to (eventually) take a more accommodative stance. That and a flight to safety are likely to force bond yields lower.
  • EM is likely to follow a similar, but probably more accentuated path, to equity markets with the avoidance of trade wars likely to trigger a significant bounce given the oversold state of markets. Equally, a full-blown trade war is likely to see the exodus from the asset class continue.
  • Vol speaks for itself. A full-blown trade war means weaker growth and profits, more uncertainty and risk asset sell-off. Vol has to go higher across most asset classes in such a situation. Fixed income might be the exception due to the flight to safety.

To summarize: BofA's global "late cycle" indicator has just been triggered, and both the economy and markets are now set to stagnate for the next year, or worse, if more adverse developments emerge. The best case scenario is one in which there are no additional stresses on the global economy - in this case, markets will recover and resume rising. The worst case scenario envision the trade war between the US and China escalating progressively in tit-for-tat fashion, ultimately pushing global growth low enough to prompt a recession. In this case, the 2000/2007 scenario become the dominant one, and what happens next could be a market crash of roughly 40% in the next 12 months.

Which scenario the markets will follow will depend on how the US-China (and global) trade war develops; in other words, the fate of the stock market is now in Donald Trump's hands.

Comments

NemesisteM Fri, 07/06/2018 - 15:11 Permalink

Good, let the banks fall on their fucking faces.

The jew created system of usury needs to crash and the parasites need to die off so that a better way of life can take place. 

Corporations can follow suit.  Too much power in too few (jew) hands.

Buckaroo Banzai Rapunzal Fri, 07/06/2018 - 15:20 Permalink

Give me a break. By every valuation metric extant, the market is due for at least a 40% crash no matter what happens. Trying to pin the blame on a "trade war" is a typical kike misdirection play. Same thing happened in the 1930s, the Jews tried to blame Smoot-Hawley for the depression, when the real culprit was Jewish money manipulation via the Federal Reserve, stock market pump-and-dump shenanigans, and that cunt FDR interfering with everything he could get his grubby little shabbos-goy hands on.

In reply to by Rapunzal

gdpetti khnum Fri, 07/06/2018 - 15:38 Permalink

And this is just the usual 'out with the OWO, in with the NWO'... only this time it's the end of our Iron Age... which points to the end of the previous age, the Bronze.... like many empires that collapse when Mother Nature swings in .... this time it's full force as the 'gods' or comet cluster is returning after the 'dark star' passes over the ecliptic plane... it rejuvenated the cluster in its pass through the Oort Cloud.... hasn't done that in ~28 million years... so we get to see the it like new, won't that be nice for our 6th Extinction protocol? Meanwhile, the game goes on... out with their OWO.... in with their NWO... seems the CHinese havn't been informed, same with our political puppets in DC/London/Rome/Berlin... they are playing the same ole game for regime change, but their SG masters are outing the old for their new game... thus the reset between the major powers.... the equalization process.

In reply to by khnum

Blankfuck Fri, 07/06/2018 - 15:30 Permalink

This so called market is a fraud, controlled and manipulated with ponzi funny money. Been for years now. No crash, no volatility-just  bullshit

Enrabard Fri, 07/06/2018 - 17:06 Permalink

Looking at old charts before 2000 they wouldn't be able to predict 2000 and 2007 crash so what is a value of such analysis now? 2018 can be a completely new chapter also. 

MrNoItAll Fri, 07/06/2018 - 17:24 Permalink

The crash was going to happen anyway, without doubt. IS going to happen anyway. "Trade Wars" was created so that the elites have someone and something to blame. Xi can tell his people "Trump did it". In fact, politicians and elites all around the world will be pointing their fingers at Trump and "his" Trade Wars. It's so obvious what these propaganda masters are up to.

BankSurfyMan Fri, 07/06/2018 - 17:55 Permalink

There are two types of crashes... "Holy Jesus, we almost CRASHED!" Then there is the other crash! "We are F'cking Dead!" Doom, stocks crash 2019! Not 2018! NEXT!