‘1999-Lite’, Why Markets Are Up Big, And What Comes Next

We’re living in “1999-lite”, according to one bank’s popular weekly flows update.

It’s all about central banks and their Herculean efforts to push rates lower, compress spreads, and tamp down volatility, BofA’s Michael Hartnett writes, in this week’s “Flow Show”.

Naturally, this begets “speculative froth”, he says, citing a doubling in the IPO ETF since the March lows and China’s STAR board trading at 109x, among other manifestations of bubbly markets.

It also helps that “there was no Lehman this time”, Hartnett notes. Thanks to $18.5 trillion in global stimulus, “widespread bankruptcy and defaults” were averted, despite the stunning economic collapse that accompanied lockdowns across all major economies.

This time, policymakers didn’t wait around.

Of course, there are plenty who will tell you the bankruptcy wave is still coming — that’s it’s just a matter of time.

And those folks will be forgiven. After all, Fed support and massive intervention by Congress hasn’t saved everyone. The second quarter still saw the most bankruptcies for firms with $50 million or more in liabilities since 2009.

Additionally, some worry the trillions in new debt corporates took on in 2020 will eventually prove difficult to service, especially if the global recovery doesn’t play out as planned.

Households were in better shape headed into the pandemic than in the financial crisis, but the corporate sector is over-leveraged and we all know the story with government debt.

In any event, just as expansions “don’t die of old age”, rather “they are murdered” by the Fed, neither are bubbles popped by investors suddenly turning bearish. Instead, bubbles are burst by central banks, Hartnett says.

With “the price of money at all-time lows”, bubbles in credit and bonds can serve to further inflate bubbles in stocks, especially growth proxies and corners of the market tethered to the duration trade in rates.

So, what’s it going to take to engender faith in the reflation narrative and catalyze all the rotations that would go along with it?

Well, you already know the story — or at least you should. Hartnett notes that trepidation remains despite recently strong data, and that the hesitancy to embrace the recovery story isn’t all about rising virus cases in the US. It’s also about fiscal cliffs, including the expiration of extra federal unemployment benefits (barring congressional action) later this month.

In the July edition of BofA’s Global Fund Manager survey, CIOs and CEOs expressed a preference for debt reduction over capex. That, Hartnett says, “encapsulates the lack of conviction in the recovery”.

He continues, noting that until folks are more convinced that a constructive economic narrative is both viable and durable, any pro-cyclical rotation (e.g., from high-grade to high yield, from mega-cap to small-caps, or from secular growth to value) will be “only partial”.

“A big top in asset prices and a big rotation to inflation is coming”, Hartnett writes, “but a necessary condition for both… is stronger US employment and wage growth”.

Well, stronger employment, wage growth, and, of course, progress on vaccines and therapeutics. What we really need are game changing treatments that suggest humanity has triumphed over COVID-19 once and for all — conclusive evidence that science has prevailed in the battle to subdue a biological threat.

As for right now, Hartnett remains tactically bullish, at least until a “top coincides” with i) a vaccine, ii) the introduction of yield-curve control by the Fed, and iii) signs that the laggards are beginning to outperform as a rotation finally takes hold.

Structurally, though, he’s bearish, and that bent is reflected in an asset allocation that entails being 25/25/25/25 in stocks/bonds/cash/gold, if you want to be “conservative”, or “growth”/”yield”/”quality”/”inflation” if you want to be “aggressive”.

For what it’s worth, the day that I, personally, am ever 25% in gold will be the day I move off this island. So, never.