One Bear Is ‘So Tempted’ To Turn Contrarian Bull. Alas…

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.