Well, BofAML isn’t mincing words to start the week.
In a note dated Monday, the bank has the following rather unequivocal message for clients:
Yes, “sell before it’s too late.”
Their rationale? Simple: the US economy is rolling over as is clearly evident from the incoming data.
But more interesting is the bank’s take on the Fed hike.
Essentially, BofAML says there’s no way in hell the Fed is looking through poor inflation prints, etc. In reality, what they’re doing is responding to financial conditions that are too loose and more specifically, they’re looking to short-circuit the out-of-control tech rally that’s created a self-feeding loop wherein FAAMG has become synonymous not only with growth and momentum, but also with low vol.
If that’s allowed to continue, and if large-cap mutual funds and hedge funds perpetuate it, the fallout from a reversal of the heretofore virtuous circle could be catastrophic.
A market with risk off written all over it
A string of weaker-than-expected US data over the past week has only strengthened our view that the US economy is losing momentum. We continue to believe the culprit is the lack of progress in tax reform. Companies after companies across the country have been telling us lately that they are withholding major decisions on hiring and investment until there is greater clarity on tax reform. This should come as no surprise. Running a business without knowing what taxes you will be paying, whether interest and labor costs will be tax deductible, how long you have for capital expenditure depreciation is like driving at night without headlights. If you can’t see, you slow down ─ the increased uncertainty around tax reform has become a damper on economic growth.
The data are bearing out this wait-and-see attitude. Core durable goods orders have been flat for three consecutive months and the three-month moving average of nonfarm payrolls slowed in May to the most sluggish pace since the Eurozone crisis in 2012.
Hawisk Fed won’t help tech stocks
Against this backdrop, we were surprised by the hawkish tone struck by the Fed last week. We wonder what it sees (“solid” job gains, business fixed investment that “continues to expand”, risk to the economy being “roughly balanced”) that we do not. Can it be the case that its hawkishness was prompted by something other than its reading of the economy?
For example, is it possible that the Fed has become concerned about the recent surge in the equity market, especially tech stocks that has been feeding off low interest rates and low volatility? According to our equity strategists, the P/E of the tech sector (19x) is currently at its highest levels post-crisis while the EV/Sales ratio is at the highest sinec the Tech Bubble.
Whether the Fed’s hawkiness was indeed intended as a warning shot to tech stocks or not, momentum behind the recent tech rally was already fading even before the FOMC meeting. The fact that large cap active funds have never been more overweight the tech sector in the history of our data and the possibility that there could be a bigger correction ahead make us think that the balance of risks for both US rates and USD/JPY remains on the downside (notwithstanding the Fed’s plan to hike one more time and to start shrinking its balance sheet this year).
Oil price on the brink
The price action in the energy market is also raising a red flag in our eyes. In the face of continued inventory build and increasing rig count (Chart 2), WTI front month contracts fell to a two-month low last week. Our technical analysts believe if WTI breaks below $44 per barrel (it is currently at $44.68), $38-40 levels could be in play.