With the stock market heading no where for the last 4 months of this year, it is high time we took a step back and view things from a systematic angle. As we approach the "sell in May and go away" phase of the year, equity returns are looking more vunulrable to adverse shocks, and flares in volatility. Indeed, the markets have seen bouts of huge directional swings lasting weeks to months each time, each cancelling the other out.
YTD, the S&P 500 is almost unchanged, down marginally. Bonds (quality) and commodities (short USD) have been the best performers for the last 4 months. Vol of vol (VVIX) has remained elevated but is not yet deemed to be at alarming levels. What's in store for us may be a surprise. Or actually maybe not.
Alas when we analyze economic data and trends in corporate earnings, we find nothing bullish.
- Macro data has been borderline on the side that supports the littlest of hawkish Fed policy, although this could turn on a dime.
- The S&P 500 is officially in an earnings recession (2 quarterly declines in EPS growth in a row).
- Monetary policies adopted by major central banks (Fed, ECB, and BoJ) have largely been ineffective at creating excess returns for equities like they used to in the past. An indecisive Fed has spelt volatility in stock prices and the U.S. dollar.
When we piece this puzzle back in a way BofAML calls the "3P's of Positioning, Policy & Profits", we can come to the conclusion that the risks are skewed south, and things could turn uglier very promptly. While we do not make predictions, it is looking more likely that stocks continue to trade in a very wide range spanning 1900 to 2100 on the S&P 500 (i.e. ~200-point / ~10%) range.
Therefore, it may be wise to expect very moderate returns from equities. One may wish to overweight cash, bonds, and gold while avoiding equities and non-IG corporate credit.
This Friday's non-farm payrolls (NFP) report for April may well be the straw that break the Fed's back, should we get a number far below consensus estimates and a lower than expected growth in hourly earnings. Regardless of that, volatility in Fed speak should likely continue to translate into volatility in the capital markets, and further rattle the dollar both ways.
"A Summer Of Shocks" by BofAML's Michael Hartnett:
2016 YTD global total returns: commodities 7.6%, bonds 7.5%, equities 1.1%, the US dollar -5.8%.
Our base case remains:
- End of excess liquidity + end of excess profits = end of excess returns = higher weightings in cash, volatility & gold in 2016
- Shift from "raging bull" (2009-13) to ‘sitting bull” (2014-15) to “volatility bull" (2016) reflects: a. low probability of Higher EPS & Lower Rates, and, b. redemption, repression, regulation risks
- Positioning + policy correctly caused Feb-April risk-rally; post-March we have been sellers into strength; case for volatility once again rising driven by the “3P’s” of Positioning, Policy & Profits
The bullish “positioning shock” is largely behind us
Our BofAML Bull & Bear index has jumped from an uber-bullish 0.1 level in Feb to 5.1 today, an 11-month high (Chart 5); cash levels, which were at 15-year highs in Feb according to the BofAML FMS, are falling as investors rotate from cash to corporate bonds; BofAML private client equity allocation is back up to 59% (up from 56% in Feb’16, albeit below all-time high of 63% in Mar’15).
The bullish “policy shock” is largely behind us
The policy “panic” of Feb & March was ended with the BoJ decision last week to disappoint market expectations of further easing; Quantitative Failure stalks Japan (see yen surge and unbelievably low level of JGB yields - 0.31% for the 40-year yields; debt deflation stalks China (watch CN0C Index); and while the ECB is limiting credit spreads, recent ECB actions have coincided with higher euro, not higher bond yields, bank stocks & inflation expectations; meanwhile Fed willingness to raise rates likely will continue to create fear of “events” (Chart 6). The likelihood of a Trump-Clinton election match-up supports our Main Street versus Wall Street theme. Both candidates state support for the working class versus the rich.
There is no bullish “profit shock”
Global EPS (Chart 7) & global GDP forecasts continue to be revised lower; good, reliable, cyclical lead indicators, e.g. the SOX index, are rolling over/heading back toward floor of 18-month range; and the decline in US corporate profits has extremely ominous implications for US payroll numbers (Chart 8) in coming months (consensus looks for 200k on Friday). Watch credit: the global high yield index (HW00 Index) is approaching all-time highs; a break above 330 would be risk-on, but we think credit fails to hit new highs.