It’s “so tempting to be a contrarian bull,” BofA’s Michael Hartnett said.
After all, bonds have crashed. And I mean really (really) crashed. According to an index from Global Financial Data, which appends historical records to more conventional series, world government bonds are on track for their fourth-worst year since 1700. And US equities, while not necessarily a “bargain,” are trading near 15x on a forward multiple.
“Everyone is bearish,” Hartnett wrote, in the latest installment of his popular weekly “Flow Show” series.
I’d be remiss not to refer readers back to the rather remarkable figure (below), which shows that the combined drawdown in stocks and bonds exceeded $35 trillion this year, a value destruction event with no precedent.
The bear market in stocks may or may not be among the more painful episodes in living memory (two of Bloomberg’s terminal bloggers debated the relative merits of using superlatives on Thursday), but when considered alongside the gratuitous bloodletting in bonds, and the worst year I can remember in high-grade credit, 2022 will live in infamy.
Typically, these sorts of drawdowns are buying opportunities, especially considering the possibility that the selloff at the short-end of the US bond curve is mostly over. Once the bull steepening kicks in, the tide can turn, assuming, of course, the bond market gets the Fed right.
So, I sympathize with Hartnett’s contrarian bull temptation. “Markets are rebelling against QT,” he went on to write, in a kind of point-counterpoint exercise, weighing the rationale for a Q4 rally versus the case for new lows.
If you’re in the bull camp, you might argue that 3,600 is the floor for the S&P and 4% the ceiling for 10-year yields. Those levels have held, and when we approached them, it “triggered financial systemic fears,” as Hartnett put it. He also pointed to “cracks in the US labor market and housing,” which could “engender renewed hopes that the Fed cut[s] rates toward the end of 2023.”
The figure on the left (above) suggests a turning point for jobs and wages. The figure on the right shows the above-mentioned selloff in the historical index of global bonds.
And yet, BofA’s “bias” is for new lows this quarter. Early policy “panics” may fail, Hartnett cautioned, suggesting the yen and UK bonds could make new lows despite intervention from the finance ministry and Bank of England, respectively. The bond crash and an oncoming recession will likely pressure corporate earnings, and thereby stocks and corporate credit, he added.
BofA’s pseudo-famous Bull & Bear Indicator remains parked at 0.0, “extreme bearish” territory, and an ostensible contrarian “buy” signal (figures below).
Suffice to say the signal has loitered near 0.0 for quite a while, and although it did presage the summer rally, policy realities make it very difficult to be a contrarian or to otherwise lean against the (gale-force) bearish wind.
Notably, evidence of retail capitulation remains conspicuously absent. Regional equity flows reflect what you’d expect under the circumstances (e.g., European equity funds in the worst streak of outflows in a half-dozen years), and $43 billion has come out of active funds over the past four weeks. But equity ETFs have taken in almost $50 billion over the same period. As Hartnett wrote, we’re “just not seeing classic equity flow liquidation.”
Ultimately, the question for investors remains the same: “Hard landing or soft landing in 2023?” BofA says hard landing.
Bank of America says hard landing- I would propose that there is going to be a hard landing in certain sectors but not others. No crystal ball here at RIA but you can bet the typical cyclical sectors are going to take a further hit within the next 6 months. I am thinking banking and finance, real estate, tech (yes tech is cyclical), energy and consumer durables(including autos). These will probably be the sectors a rotational player reinvests in when you think the economy is going to turn (except perhaps for energy which is late cycle usually).
I’m an equity bull when 1) estimates are hit hard, 2) CPI is clearly easing, 3) FF is in sight of >4%, 4) SP500 < 3400. That may not mark exact bottom but I think will be close enough. Until then I’m picking at individual names that are very undervalued (there are lots) and adding to energy overweight. I’m expecting to be a bond bull before I’m an equity bull. That said, I think a 4Q rally is quite possible.
I’m actually qute excited about bonds. At some point, that is getting closer and closer, it will be possible to “lock in” 4% to 6% yields at zero to tolerable credit risk and quite low duration risk. That will meet a lot of portfolio needs.
Many IG muni opportunities at 5%+. In my bracket those are roughly 7% pretax equivalent. Most of what I’m buying are insured, have sinking funds or both, as well as ten year call protection. At 78, all I need.
Equity bull scenario talked about this week is 1) very big financial system breakage, 2) not fixable short of abandoning tightening. Not sure that is really bullish, unless consder 1970s a bull market. At best an unhealthy, mishapen bull – don’t expect a comfortable or long ride.
Supporting the bond bear thesis is that, while the sell off in bonds is historically huge, it started from historically high levels. Relative to historical valuations, current bond prices aren’t an outlier by any metric. Historical.
My most contrarian bullish potential activity at present involves reducing my short hedges on S&P 500 and Russell and redeploying into another tranche of long term treasury funds to add to my underweight position…that’s about it at this juncture…