BofA: “A Deer In The Headlights” Market Moment

Looking at the latest fund flow data from EPFR, BofA CIO Mike Hartnett describes the most recent developments in capital flows with 4 ominous words: “deer in the headlights.” He is referring to the unexpected risk-off investor sentiment in the past week, a continuation of last week’s theme, which saw $2.8bn inflow to bonds, $0.9bn inflow to gold, while flows to equities remained unchanged.

Taking a closer look at equity flows, Hartnett notes the collapse in stock “froth” which following massive 2018 inflows of $150bn in the first 2 months of the year, has reversed and equity redemptions have surged to $30bn in the past 6 weeks.

Further narrowing the number down, there was 3% outflows, or the biggest outflows in 3 months, from tech, couped with the biggest HY outflows in 2 months, and biggest EM debt outflows in 10 weeks. In other words, a sudden risk aversion to the highest beta risk-on products and sectors.

Still, it’s too early perhaps to call a top as the 9-year bull leadership intact: flows into tech & EM debt/equity funds nonetheless close to record highs; in fact, only HY funds have seen “bear market” in flows.

Or maybe note: YTD returns are poor & stagflationary: oil 12.9%, commodities 6.1%, equities 0.2%, bonds -0.4%, cash 0.5%, US dollar -0.6%, 30-year US Treasury -7.4%. As Bank of America noted last week, the last time we saw performance such as this was… in 2007.

How did we get here? Recall that 2018 consensus was Goldilocks: higher growth, higher EPS, “good” rise in yields to >3%, sustained equity outperformance (this after Feb’16 lows to Jan’18 highs global market cap up $33tn). However it now appears that both profits and economic growth are peaking: 2018 EPS/GDP = peaking: EU/Japan/China exports & PMIs have peaked; 5 months after large corporate tax cut (and large equity gains – Chart 2), US capital goods orders unchanged.

To be sure, there are some good news, if only for the equity bulls:

First: the recent episode of “froth-off” means that BofAML’s “Bull & Bear” Indicator is back to @ 5.4, or a neutral reading; May FMS investor cash levels jumped sharply to 5%; May FMS tech “long” fell to 5-year low.

Second: the market is now clearly saying that Fed tightening = policy mistake: one can see that in the chart of US homebuilders which are a good lead indicator of Fed funds; other policy mistake price action = flattening yield curve, rising rates ≠ higher bank stocks.

But wait, there’s even better news: according to Hartnett we may be approaching another “Shanghai Accord”, i.e., another “synchronized monetary blinking”: consider China is easing (the 1st catalyst for US$ rally) & BoE/BoC/Riksbank all “blinking” as FX appreciation + no global inflation allows central banks to turn dovish.

So what is BofA’s reco? Do the contrarian trade, which is to buy in May: peak EPS + cleaner positioning + dovish central banks + China easing = rip in tech & EM…which we will look to sell.

Meanwhile, for the non-contrarians, the cleanest trade is long US$: at least until Fed “blinks”; BofA also notes that the US-Europe 10yr yield spread ios now widest since fall of Berlin Wall.