With every passing day, the bizarre freakshow that was once known as the “market” gets even more bizarre.
And we use the term “market” only in its loosest, legacy sense, one where it represented more than just the centrally-planned intentions of a few central bankers and politicians. Why? Because as BofA’s CIO Michael Hartnett reminds us in his latest Flow Show report, the disconnect between macro and markets has never been greater – i.e., they have never been more broken – but that is to be expected for the following three reasons:
- Markets rationally being “irrational”: government and corporate bonds have been fixed (“nationalized”) by central banks, so why would anyone expect markets to connect with macro, why should credit & stocks price rationally.
- Markets leading macro: policy makers (see China this week) know higher asset prices necessary condition for macro recovery (Wall St assets are 5.6x size of US GDP)…
…V-shape recovery on Wall St leading V-shape recovery on Main St (see PMI’s & housing activity); gasoline demand good US mobility signal, up sharply to 9mn barrel/day from spring lows, watch to see if virus again negatively impacts economy.
- Markets rationally pricing-in Max Liquidity, Minimal Growth backdrop, as they have done for 10 years; of 3042 stocks in MSCI ACWI currently 2141 >20% below their all-time highs, i.e. in a bear market.
Also consider this: if the S&P500 (3230 on Jan 1st) was just “tech, health care, Amazon, Google” it would now be 4173 , and if the S&P were “everything else” it would be 2924. No secret here, but US tech outperformance over US banks past 6 months biggest since 1999 tech bubble & 2008 GFC.
So while markets may be broken – as one would expect in a world where central banks have taken over all price discovery – three key trends remain and are totally unchanged for 2020. Per BofA:
- Central bank liquidity drives asset prices;
- Credit prices drive equities;
- Sellers’ strike in credit & tech mirrored by buyers’ strike in value stocks & banks.
Some other observations from BofA’s CIO on what was once a “market”:
Cash & gold the big inflow winners in 2020;
Gold inflows on cumulative basis at all-time high:
Discounting all-time high in price; largest inflow to China funds ($6.1bn) since Jul’15 (and 2nd inflow largest ever):
So with stocks now fully mandated and no longer discount the future or respond to fundamentals or news, does this mean that stocks will rise indefinitely until eventually the population burns down the Marriner Eccles building? According to Hartnett the answer is now, and while stocks see bullish drivers of Positioning & Policy into the summer, these will peak just as the autumn begins, at which point bulls will require profits to surprise to upside allowing rally in risk assets to broaden into HY, value stocks, small cap and so on; At the same time, bears will argue that big 2020 underperformance of banks a signal of no economic hope & sinister repeat of 1999 & 2008; According to Hartnett, these are the catalysts required to boost banks:
1. Vaccine: most likely catalyst for big GDP & EPS upward revisions H2 and flip from growth to value.
2. Fiscal: 2020 policy stimulus has been massive ($18.5tn of which $10.5tn in fiscal & $8.0tn in monetary = 21% global GDP) (Chart 5) and coordinated (1st time in years monetary & fiscal, like two wheels of a bicycle, moving quickly in same direction working together); banks the natural hedge for fiscal success (key barometer to watch = small business confidence surveys, e.g. NFIB) in stimulating animal spirits.
3. Politics: rising probability of political “blue wave” i.e. Democrats winning White House, Senate, Congress (latest Oddschecker.com probabilities…Biden win 57%, Real Clear Politics probability…Dem Senate 62%); Table 2 shows annualized returns following 7 out of 21 “blue waves” since 1928…returns, more obviously in bonds, below historic averages after Dem “clean sweep” but outperformance of value over growth more pronounced; “Blue Deal” fiscal stimulus in 2021 via infrastructure, student debt forgiveness, health care spending positive value & banks.
4. Risk-taking: bank deposits up $2.2tn since end-Feb but bank loans up only $0.5tn vs cash/reserves up $1.3tn and UST+MBS holdings up $0.3tn (Chart 6); bank stocks tied-at-the-hip to interest rates (Chart 7).
If and when Fed/ECB/BoJ can ever raise interest rates global banks will become the instant leadership; ironically introduction by Fed of Yield Curve Control in Sept may in typical contrarian fashion trigger a rally in banks; but the other irony is that sustained bank performance first requires risk-taking to boost economic growth & interest rate expectations in 2021 & 2022; until then bank stock bulls will focus on China (has led virus, market & macro recovery) & Europe (start of fiscal stimulus).