Listen, BofAML’s Michael Hartnett is pretty sure we’re all in for a world of shit eventually and he’s been saying as much for quite a while now.
The collapse of the QE-fueled bull market has of course not yet materialized and if it makes it to August 22, 2018, it will become the longest in recorded history. There’s certainly an argument to be made that we can get there. The ECB is still going to be in the market through at least September (and let’s not kid ourselves, APP will ultimately be extended through the end of the next year) and if recent history is any guide, CSPP will probably be spared the brunt of the taper, meaning Draghi will continue to exert powerful downward pressure on credit spreads.
Meanwhile, you will have to pry Kuroda’s ¥16 trillion ETF book from his cold dead hands and if you think he’s just going to willingly give up control of a JGB market he’s worked so hard to corner, well then you’ve got another thing comin’.
Throw in the fact that the Fed must carefully manage its exit to avoid triggering a disorderly unwind of the bond trade (i.e. Fed must remain in constant communication with markets in order to preserve transparency and predictability) and you’ve got a recipe for the continuation of a status quo that perpetuates ever higher highs on equities and ever tighter tights in credit.
Be that as it may, the above-mentioned Hartnett is going to go ahead and quadruple down on the warnings in what, if nothing else, is a highly amusing year ahead piece called “The Big Top.”
And look, Hartnett doesn’t just have a “big top” for you. He’s also got a “big long”, a “big short”, and a “big risk”. Just call it: “Big league.” Here they are:
The Big Top: We forecast a H1 top in risk assets as the last flames of QE, US tax reform and robust EPS incite full capitulation into risk assets…targets SPX 2863, CCMP 8000; AA: equities>bonds, EAFE>US, gold>oil, bullish US dollar.
The Big Long: Volatility…peak positioning, profits, policy = peak returns and trough volatility; 50-year low in stock volatility, 30-year low in bond volatility likely to be followed by flash crash (à la ’87/’94/’98) in H1.
The Big Short: Corporate bonds…higher inflation, higher debt, higher bond volatility and end of QE era most damaging for corporate bonds; game-changer = wage inflation shatters Goldilocks consensus (no fear of Fed/ECB) via higher credit spreads.
The Big Risk: Tech bubble…AI/robots cause wage deflation extending era of excess liquidity, bond yields fall, Nasdaq exponential; “Icarus unleashed” bubble could end in 2019 with bear market on hostile Fed hiking, Occupy Silicon Valley and War on Inequality politics.
Got all that? There’s a final flaming out of the QE bubble exemplified by a blowoff top and “full capitulation” into risk assets. There’s a call for an epic spike in vol. that will accompany a flash crash (presumably exacerbated by systematic selling). There’s the contention that the sudden emergence of wage inflation could force the Fed/ECB’s hand and trigger a bloodbath in credit. And then for good measure there’s the contention that robots might keep us trapped in a deflationary death spiral necessitating still more QE and Nasdaq infinity, which will in turn trigger class warfare and a popular revolt against Silicon Valley.
“Are you not entertained?!”
Additionally, Hartnett lists all kinds of fun things that have happened in 2017, presumably in an effort to convey the sheer absurdity inherent across assets:
- Da Vinci’s “Salvator Mundi” sold for staggering record $450mn
- Bitcoin soared 677% from $952 to $7890
- BoJ and ECB were bull catalysts, buying $2.0tn of financial assets
- Number of global interest rate cuts since Lehman hit: 702
- Global debt rose to a record $226tn, record 324% of global GDP • US corporates issued record $1.75tn of bonds
- Yield of European HY bonds fell below yield of US Treasuries
- Argentina (8 debt defaults in past 200 years) issued 100-year bond
- Global stock market cap jumped1 $15.5tn to $85.6tn, record 113% of GDP
- S&P500 volatility sank to 50-year low; US Treasury volatility to 30-year low
- Market cap of FAANG+BAT grew $1.5tn, more than entire German market cap
- 7855 ETFs accounted for 70% of global daily equity volume
- The first AI/robot-managed ETF was launched (it’s underperforming)
- Big performance winners: ACWI, EM equities, China, Tech, European HY, euro
- Big performance losers: US$, Russia, Telecoms, UST 2-year, Turkish lira
Oh, and here’s another fun stat for you. As Hartnett notes, “equities have only outperformed bonds for seven consecutive years on three occasions in the past 220 years, the last time was 1928”:
Ironically, BofAML is going to go ahead and start out 2018 “with a pro-risk asset allocation of equities>bonds, EAFE>US, gold>oil, bullish US dollar.”
As Hartnett explains, “we believe the air in risk assets is getting thinner and thinner, but the Big Top in price is still ahead of us.”
Naturally, that might make you wonder if there’s any chance we’ll get a warning from BofAML before everything described above starts to play out or whether we’re at the mercy of the circuit breakers. Well fear not, because Hartnett says he “will downgrade risk aggressively once he sees excess positioning, profits and policy.”