‘The Top’ Is Near And The World Is Changing

The top in asset prices will come between the election and inauguration, BofA’s Michael Hartnett says, in the latest edition of the bank’s popular weekly “Flow Show” series.

Hartnett, who reiterates many of his recent talking points, writes that “peak policy” will be the “key driver” of the topping process, and calls it “curious” that a prospective blue wave election outcome has turned into a bullish catalyst for market participants over the past month or so.

One explanation for the market’s reassessment of the ramifications for risk assets of a Democratic sweep is that Donald Trump’s refusal to commit to a peaceful transfer of power was a bridge too far for many market participants — the prospect of a US president literally refusing to relinquish the keys to the castle following a lost election appears to be the one thing capable of overriding the allure of lower corporate taxes in the minds of some investors.

The latest polling, which includes the time period following Trump’s COVID-19 diagnosis, shows Biden extended his lead in the wake of Trump’s hospitalization and recovery. Even Fox has Trump down double-digits.

When it comes to equities front-running fiscal stimulus, BofA’s Hartnett says rising blue wave odds are prompting a “green wave” rally. He notes the solar energy ETF going parabolic, but also observes that NextEra Energy now sports a market cap larger than Chevron’s.

“This green bubble is gaining momentum,” Kevin Muir, former head of equity derivatives at RBC, said this week.

“The world is changing more quickly than I imagined. We’ve hit the tipping point, and it’s expanding at breakneck speed,” Kevin added, noting the same surge in the solar ETF flagged by Hartnett. “Whether it’s the move to electric cars, or the adoption of solar power, society is adapting quickly to the new reality.”

Exxon is the poster child for legacy energy’s fall from grace. The company, once the world’s largest, rang up a $1.1 billion loss in the second quarter, making what was already unprecedented even more anomalous.

You can take the figure (above) back as far as you want – you will not find a comparable quarter. Recall that Exxon reported zero cash from operating activities for the period. It was ejected from the Dow in August.

All of this points to a changing world — or at least that’s the plan. But, as we saw four years ago, the best-laid plans have a way of going awry.

And do note that even if the political situation stateside evolves as many now expect, it’s still likely to be a messy trade. After all, rising yields and a steeper curve would be conducive to a rally in pro-cyclical shares, including “old” energy and banks. But both legacy energy and financials could be targeted in a Biden presidency, as the shift to clean power further undermines the long-term fortunes of the former and the prospect of an Elizabeth Warren Treasury bodes particularly ill for the latter. (Lael Brainard is the far more likely choice for Treasury secretary under Biden, but you never know.)

For his part, BofA’s Hartnett reminds you that “capitulation into lagging assets [is] always the last domino to fall in a big rally,” and in this case, that would mean money flowing into banks, energy, and small-caps as bond yields jump.

Good luck sorting all of this out. I suppose one risk for equity investors is simply that if the world does change for the “better” (as discussed here on Thursday evening), making money in markets could conceivably require more skill going forward. That, as opposed to the post-GFC world in which things were as simple as buying SPY for 9bps and being virtually assured of besting most “brand name” hedge fund managers in any given year.