BofA's periodic report on "The Biggest Pictures", published by Chief Investment Stategist Michael Hartnett, is always a treat, if for no other reason than the remarkable context it provides on some more contemporaneous themes such as rates, markets and core secular economic forces (such as the 4 deflationary Ds of Deleveraging, Debt, Demographics and Disruption). This time, it was doubly so because it summarized the bank's "alternative base case" (the "less than optimistic" one, not carted around by Savita Sumbranaian for CNBC purposes), which notes that while the bank remains bullish on the remainder of 2019, is confident that the wheels off this market finally fall off in 2020.
This is how Hartnett explains his current investment philosophy. First the good news:
We are bullish on risk assets in 2019 as bearish investor sentiment & the irrationality of central banks and bond markets allow an "overshoot" in credit & equity prices this autumn (note trade war thus far bullish via lower rates rather than recession).
Now the not so good:
We are bearish on risk assets in 2020 as recession/policy impotence/bond bubble risks induce Big Top in credit (spreads trough) & equities (multiples peak).
This also means that when looking at the outcome for risk assets, there are two possibilities: a positive risk, and a negative one. As Hartnett explains, "the positive risk for markets is an orderly rise in bond yields and Great Rotation from bonds to stocks as policy makers successfully postpone recession."
Should that fail to happen, "the negative risk for markets is a disorderly rise in bond yields as bond bubble bursts causing Wall St deleveraging & Main St recession."
Excluding contingencies, Hartnett's current positioning is as follows:
Bullish stocks, bearish bonds, bullish commodities, bearish cash, and bearish the US dollar.
We predict a "Big Top" in asset prices in coming quarters once policy stimulus peaks and/or policy impotence is visible.
Despite the trade war grabbing all the headlines in 2019, returns from equities, bonds & commodities have been incredibly strong as once again bearish positioning & bullish monetary policy have trumped the macro.
Meanwhile, since everyone is positioned to expect further yield downside as the most recent Fund Manager Survey showed with recession expectations the highest since the financial crisis, Hartnett believes that "the most contrarian trade in the 2020s is "long inflation", meanwhile the "War on Inequality" is ultimately bearish for asset prices; Such a scenario would be "an overshoot in equities & credit likely to be followed by overshoot in gold and outperformance of value stocks versus growth stocks in 2020s."
Next, to summarize the various secular themes that dominated the current decade and what he expects will be market moving in the next ten years, Hartnett shows the following breakdown of core market themes:
That wraps up the investment reco part of the report, which then brings us to our own favorite part, the odd (or "biggest" as Hartnett calls it) statistics, which are as follows (highlights ours):
- 3498: the S&P500 level which makes the current bull market the biggest of all-time (it is already the longest)
- 27%: excluding the US equity market, the MSCI global equity index is still 27% below its 2007 high
- 17%: European financials as a % of MSCI Europe, down from 31% in Jan'09
- $5.4tn: US corporate spending on stock buybacks since 2009
- $15.0tn: US corporate debt issuance since 2009
- $114: amount US companies spent on buybacks since 2018 for every $100 invested in the real economy (it was $60 between 1998-2017)
- 5.4x: US private sector financial assets are >5.4x the size of US GDP (compared to 2.5-3.5x between 1950 & 2000)
- 731: the number of global interest rate cuts since Lehman
- $12.4tn: the amount of assets purchased by the big 5 central banks (Fed, ECB, BoJ, BoE, SNB) since 2009
- $17.0tn: value of negatively-yielding bonds (equivalent to 30% of total outstanding debt securities market value)
- $1tn: value of negatively-yielding corporate bonds
- $325bn: inflows to bond funds globally in 2019, on pace for record year
- 0.2%: the average yield of the 10-year government debt of the US, the UK, Japan, Switzerland, France, Australia
- 1100: number of global stocks with dividend yields more than 300bp above average global government bond yield
- 319%: global debt is near an all-time high level of global GDP
- 20 million people: working population decline in Japan/Russia/Southern Europe between now and by 2025
- 28%: tech & ecommerce represent 28% of all US profits, a level typically associated with major sector peaks
- 3.4%: unemployment rate in 11 election battleground states, down from 4.4% since 2016 US election
- 1969: the last year US tariffs on dutiable imports were 10.6%, the level they have risen to in 2019
Of the stats above, certainly the most jarring is the number of rate cuts "since Lehman", as the world returns to a low-rate regime after a brief and explosive attempt at renormalizing monetary policy (which as everyone knows ended with a bang in Q4 2018). Putting that in context, Hartnett notes that "The 2020s will begin with the lowest interest rates in 5000 years"
And some additional observations:"
The lowest global interest rates in 5,000 years are driven by…
- …the need to sustain a weak global economic recovery post the Global Financial Crisis (real GDP has averaged 2% in US, 1% in EU & Japan past 10 years)…
- …sharp slowdown (12% to 6%) & rebalancing in the Chinese economy…
- …the surplus of global savings relative to investment, i.e. extremely low "animal spirits"…
- …unprecedented central bank intervention in financial markets (731 interest rate cuts and $12.4tn of asset purchases by Fed, ECB, BoJ, BoE, SNB since Lehman)…
- …and the 4 deflationary "Ds" of aging Demographics, excess Debt, bank Deleveraging, technological Disruption.
Deleveraging: banks, crucial providers of credit, have been shrinking balance sheets (note market cap of financial sector down from 26% in '07 to just 16% of global stock market today).
Debt: driven by corporations and governments global debt up from $105tn in 2008 and $247tn in 2019; higher debt has not led to higher growth.
Demographics: US labor force growth leads US inflation and set to remain very low in coming years; in Japan/Russia/Southern Europe working population will contract by 20 million by 2025.
Disruption: AI, VR, CRISPR, EV...rising supply of labor, services, goods via technology…lower inflation.
* * *
Meanwhile, Deflation has delivered a non-stop liquidity bubble...
…extreme wealth inequality…
…and Wall St still "too big to fail"
- Modern economic expansions now driven by booms and busts in financial cycles. The coming bust in the fixed income market will inevitably lead to extreme pain on Wall St and quickly thereafter the real economy. This is why Fed policy pivot on weak credit markets so aggressive in Dec'18/Jan'19.
- 10 years on from the Global Financial Crisis, Wall St remains too big to fail.
- In coming quarters a policy mistake (inflation targeting/MMT) and/or the start of policy impotence (central banks pushing on a string) will likely cause a jump in interest rate volatility, end the decade-long bullish combo of Minimum Rates-Maximum Profits, signal the Big Top in asset prices.
But the moment of error & impotence has yet to arrive. And thus the bull market continues in 2019.