If you're one of the enlightened few who's finally overcome all lingering doubts and decided to go whole-hog on this inexorably buoyant bull market, Bank of America Merrill Lynch has a message for you this holiday season: don't.
Analysts at BAML Global Research sent out a note Thursday predicting that “sometime between Thanksgiving & Valentine’s Day” the S&P 500 will see a 10-plus-percent correction, which in today's comatose market environment is tantamount to the arrival of the antichrist. The danger arises from the simultaneous peaking of what BAML considers the equity market's three biggest drivers: positioning, profits and policy. Since February of last year, those factors have driven everything skyward:
In the past 18 months the global stock market cap is up an epic $18.5tn (>GDP of the US), propelled by wary Positioning in stocks & credit, a strong Profit recovery and the aforementioned monetary (& some fiscal) Policy stimulus.
But now that the global economy is finally lurching forward more-or-less uniformly and inflation fears are vanquished, the consensus view has shifted from cautious optimism to melt-up delirium – in BAML's words, “Icarus unleashed.” All that conspires to create a bubble ripe for the puncturing, perhaps by a Fed tightening faster than expected, perhaps something else. It's bad news for bulls, good news for bears and equities traders starving for volatility.
If this all sounds too vague and hypothetical, BAML provided a list of 10 triggers that would set off the coming holiday horrorshow (like a recipe on the back of a chocolate chip package, these triggers just happen to require you to use BAML's other proprietary products):
- Sentiment. “Sell when the BofAML Bull & Bear Indicator exceeds ‘sell signal’ of 8...BB indicator currently 7.4.”
- Low cash allocation. “Sell if cash levels in BofAML Fund Managers Survey fall to 4.2% from 4.7% in the next 2-3 months.”
- High equity allocation. “Sell when GWIM private client equity allocation exceeds 63% all-time high (currently 60.6%).”
- Tech top. “Sell when GWIM private client FAANG exposure exceeds its 12.9% weight in the S&P500 weighting (currently 9.9%).”
- Manufacturing slide. “Sell when the US ISM index drops sharply toward 52 (3-month moving average – currently 58.6).”
- Central bank retreat. “Sell as we approach March’18, the month of peak liquidity as measured by the BofAML forecasted level of G4 central bank balance sheets; it will peak at $15.3tr.”
- Euro bond spreads. “Sell when the 10-year spread between Italian & German government bonds rises back above 200bps (currently 165bps); same for Spain (currently 122bps).”
- Policy bathos. “Sell when peak policy climaxes with US tax reform, a classic ‘buy the rumor, sell the fact’ market moment.”*
- Wages and inflation. “Sell when inflation threatens 3½% US wage growth & 2½% CPI, levels that will provoke volatility.”
- 1987 redux. ”Sell when a much sharper 1987/1998 correction is threatened by a ‘market structure’ event, i.e. passive investors, risk parity & quant funds become forced sellers, while vol sellers become forced buyers.” (Don't tell Shiller.)
* There's one curious part here on BAML's tax reform prediction: “If tax reform engenders more capital spending that means less money for share buybacks ($3.5tn past 8 years).” Why would that be the case? Companies get a sudden windfall and decide that not only will they use it on capex they've avoided for the last decade, but will also reduce their shareholder payouts to do so? How does this follow?