Bank of America Merrill Lynch has been warning for a few months now about a stock market decline so sudden and forceful that it requires allusions to both Greek mythology and nursery rhymes to fully comprehend. The bull run of the past eight and a half years is the “Icarus trade,” BAML contends, and it will end not by flying too close to the proverbial sun, but by transforming abruptly into an anthropomorphized egg and falling off a wall.
Well, Icarus has been in flight for awhile now – since January, at least – so it's high time we look out for Humpty Dumpty on the horizon. A couple months ago BAML suggested it could come as early as the holidays. And since they've primed us all to brace for impact every time the VIX gets above 12, BAML now has to inform investors whether every half-point move in the S&P 500 is “the big one.”
Thursday, it turns out, was just a “dress rehearsal for potential meltdown.” Phew.
Though recent weaknesses in high-yield and emerging market assets spells trouble, BAML says, investors are still pumping up tech and investment-grade bonds and tech stocks, the latter of which saw record inflows this week. The “recent pullback also follows insane gains,” BAML analysts write. “FAANG+BAT market cap up $1.5tn YTD, a sum larger than entire market cap of DAX ($1.4tn).” Which is a lot.
But there are warning signs. Market hipsters who follow the relatively unloved MOVE volatility index – Merrill's in-house gauge of Treasury vol – would have noticed an all-time low earlier this week, BAML noted. Presumably it can only go so low. Moreover, some psychologically impactful numbers loom: August 22, 2018, which would make the current bull market the longest ever; and 2,863 points for the S&P 500, which would make this rally the second-largest ever. “Icarus could end badly after 2863 SPX and before Aug 22nd 2018,” BAML says, 'cause why not?
But the Icarus/Humpty scenario might require a few other variables to fall into place, namely recession risk, higher wage inflation, steeper bond volatility, and moves in credit spreads. Until then, keep on flying high, Icarus. And stay tuned for Bank of America Merrill Lynch Global Research's urgent note the next time the S&P 500 has a one-sigma down day.