Dueling Investor Groups And The Risk Of A ‘Fool Me Once’ G-20

If you’re confused lately about the apparent disconnect between bonds and stocks, don’t feel bad – everyone else is too.

The bottom line is that either this is a perfect environment for risky assets as central banks’ renewed commitment to accommodative policy provides downside protection and underwrites carry mania/yield chasing, or else the global economy is headed off a cliff, bonds have sniffed it out, and anyone piling into risk assets on the assumption that central banks can save the day is a fool.

If you think that’s too simplistic, I hope you’re right. But, unfortunately, I think it’s spot-on. And so does BofA, apparently.

“Price action in recent weeks tells us that either the market is still operating in a ‘goldilocks’ regime, where lower rates means higher equities or two investor groups are dueling against each other”, the bank’s US rates team wrote Wednesday.

If we are, in fact, seeing an epic “duel”, it can be described in very simple terms.

“One investor camp is actively preparing for a recession, evidenced by the front loading of Fed cut pricing, the real yield led rates moves on the heels of dovish Fed communication, and the significant buildup in front end long positions”, BofA writes.

(BofA)

That camp has plenty of ammunition to argue their case. After all, key portions of the yield curve have inverted, ISM manufacturing printed the lowest of the Trump presidency in May, the labor market looks like it could be on the verge of cooling off and the man in the Oval Office is donning his “Tariff Man” outfit with alarming frequency.

But, who knows – maybe the optimists are correct. Maybe Trump is playing a “shrewd game” (as one contrarian opined this week) and perhaps the trade wars are nothing more than a clever ruse to compel the Fed to cut rates preemptively.

And, really, you don’t have to believe any of that to buy stocks. All you have to believe is that a pair (or a trio) of “insurance” cuts from the Fed will be enough to avert a calamity. As BofA puts it, “the other camp believes recession fears are overdone, three ‘insurance cuts’ are enough to cushion the economy like 1995 and 1998 [and] therefore bought the SPX dip.”

What happens (or doesn’t happen) at the G-20 meeting may help determine who’s right in this “Goldilocks or land mine?” debate (as BofA phrases it).

Essentially, we’re right back in the same position we were in headed into the Trump-Xi dinner in Argentina. The odds of an actual “deal” being struck aren’t high, so market participants will instead focus on any truce that delays the imposition of tariffs, similar to the Buenos Aires agreement.

That agreement, combined with a dovish Fed, catalyzed the best start to a year for global equities in decades. But given recent events on the tariff front, one has to wonder if markets would give another “handshake” deal between Trump and Xi the “fool me once” treatment.