The Shocks Aren’t Over (‘Six Fundamental Bear Market Drivers’)

Equities saw their largest inflow in five weeks, but the nascent bounce in global shares is likely a bear market rally, BofA said.

Global equity funds took in $25.4 billion over the latest weekly reporting period, the first sizable inflow since the onset of hostilities in eastern Europe (figure below).

Until the war started, inflows were tracking 2021’s pace closely, a remarkable feat considering imminent Fed tightening and the fact that last year was truly anomalous from a flows perspective.

The YTD haul is now $180 billion, just half of the cumulative inflow seen over the same period last year.

There aren’t many market participants willing to venture that this week’s stock surge (the largest since November 2020) is anything more than a positioning- / flows-driven OpEx rally.

In his latest, BofA’s Michael Hartnett didn’t mince words. “[The] ‘inflation shock’ isn’t over, the ‘rates shock’ isn’t over [and a] ‘recession shock’ is likely in H2,'” he wrote, adding that although “bear market rallies driven by positioning” are likely to be “extreme,” the “ultimate lows in stocks” and the wides in credit spreads haven’t yet been seen.

There are a half-dozen “fundamental bear market drivers,” Hartnett went on to say. The first is just that “inflation always causes recessions.” Note that Hartnett often speaks in absolutes — it’s part and parcel of his style. It’s for brevity. A corollary (and the second bear market driver) is that real wage growth is negative (familiar figure below). That bodes poorly for consumption.

Hartnett flagged rising mortgage rates and the risk that the labor market recovery “stalls” sometime this summer.

Turning to markets, there’s the “infallible” curve canary (inversions are underway) the end of QE and the combination of nosebleed valuations and too much debt, which BofA suggested means financial markets may be “quicker to negatively react to monetary tightening.”

Finally, Hartnett said the Fed’s “forecast of permanently low unemployment and transitory high inflation in the next 18 months has a very high probability of being wrong.” In his view, it’s at least possible we see a “repeat of the Fed credibility, stagflation, dollar debasement, market volatility loop” of the 1970s.

The conflict in eastern Europe led to the fourth-largest jump in the bank’s global financial stress indicator ever (figure on the left, below).

The drivers of the spike were volatility and solvency risk, Hartnett said, adding that the prior four episodes coincided with equity outflows, “but not this time.”

More notably, the other events shown in the table (on the right, above) were met with policy easing. That’s not an option for developed market central banks at the current juncture.

For what it’s worth, the bank’s Bull & Bear Indicator is now very close to flashing a contrarian “buy” signal (2.3 versus <2.0 needed).