One week after BofA CIO Michael Hartnett stated that he had observed capitulation among a subset of equity investors, noting record outflows from Emerging Markets and an exodus from European stocks amid rising fears of a global trade war ...
... Hartnett notes that sentiment has shifted as if on a dime, and has resulted in the following latest weekly flows, per EPFR:
- Back into Bonds: $5.6bn bond inflows, biggest in 12 weeks,
- Back into Stocks: $1.2bn equity inflows, all of which in the US and Japan however, outflows from EM and Europe continue.
- Back into Junk: $0.5BN, first in 9 weeks
- Back into Emerging Markets: $0.9BN inflow, first in 3 months
- Back into Defensives: largest inflows ($0.8bn) to healthcare in a year; big outflows from financials past 4 weeks ($3bn); note tech is in a lonelier & lonelier bull market.
And yet despite the prompt return of euphoria which has sent the S&P back to 2,800 after the Dow Jones was unchanged for the year just a few days earlier, Hartnett points out that not is all at it seems - if one only goes by the S&P - as YTD returns remain muted, with commodities up 4%, the US dollar +3%, equities +1%, cash +1%, and bonds down -1%, all of which are "vastly inferior to ’09-’17 QE returns, e.g. equities 16%, bonds 4%."
So clearly something has changed. To find the answer, Hartnett takes a look at the performance of winner and losers YTD and find the following:
- YTD winners: oil 17%, tech 9%, Russia 7%, US 5%, CCC junk bonds 4%
- YTD losers: industrial metals -12%, banks -8%, EM -7%, staples -6%, EM debt -4%
The surprise here is that YTD losers > winners: specifically, 34 MSCI equity indices down YTD, while only 11 up; Meanwhile 28 global equity markets have seen >10% drops, a big correction which has now spread to industrial metals, such as copper, aluminum, zinc.
One thing that has remained stable in 2018 has been the US economy, and market (both of which however have been propped up by Trump's fiscal stimulus and tax cuts), and which Hartnett calls "Red, White & Boom", however even here there is a growing disconnect between "soft" surveys and the GDP prints, one which suggests that either the economy will peak in Q3, or surveys will slide in the coming weeks:
US survey data leads GDP by 1 quarter; early ‘18 surveys predicted >5% GDP growth; now surveys say 5% in early autumn
As the next chat shows, the divergence between surveys and real GDP has never been wider.
Meanwhile, the US TSY yield curve is collapsing and appears set to invert at some point in the next 1-2 quarters, a traditional precursor to any recession:
Yield Curve & Bust: but yield curve (2s-10s) just 26bps from inversion...preceded 7 out of past 7 recessions by 4-5 quarters (Chart 4) and rotation from cyclicals to defensives
Where do these confused, jittery headfakes leave traders? According to Hartnett the answer is surprising: we have gone from a world where nobody used to fight the Fed, to one where "no one fears the Fed" any more.
Market mocks and loves Fed: linking flat yield curve, wimpy US dollar bull market, tech’s lonely bull market...belief that at first hint of trouble Fed will stop hiking...views aided by lack of US wage growth and disbelief ECB & BoJ will ever hike.
So congratulations to the Fed: it has instilled such a lack of fear of risk in the trading community that traditionally recessionary signals (flat yield curve) are now catalysts for risk purchases, with the only left risk catalyst the one which the Fed has no control over - whether Trump further escalates the trade war. However, judging by the market response in the past week, Hartnett is absolutely correct when he describes the market's belief "that at first hint of trouble Fed will stop hiking."
And, considering where the S&P is already, the market appears to have already priced in the end of the Fed's rate hikes.