So says BofA via ZH:
Well, we are finally here: 2022 has arrived and the rate shock that BofA’s bearish chief investment strategist Michael Hartnett has prophetically been warning about arrived right out of the gate, and with a bang as both nominal and real yields spiked sharply higher in just the first week of 2022.
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And unfortunately, if Hartnett’s vision for the rest of 2022 is as accurate as it has been so far, it’s going to get much worse.
Let’s start with his dismal view on the coming end of the liquidity supernova, whose conclusion will test the equity inflow supernova, which after injecting $949BN in equity inflows in 2021 (more than the cumulative inflows of the past 2 decades) is about to go into reverse. To represent this central bank liquidity flow going into reverse, Hartnett shows a chart overlaying the total contribution from BOJ/ECB QE relative to the outperformance of the FAANG stocks vs the rest of the world. What it shows is that the financial repression of Europe and Japan is a primary driver for capital flight out of Europe and Asia and into US growth stocks. All of that will end if and when the ECB and BOJ reverse their NIRP/QE (which with European inflation printing a record 5% today, the ECB will have no choice but to do):
While we have written much on Hartnett’s dour “Rate Shock” theory (see here, here and here) here is a quick primer for those unfamiliar. The Rate Shock is driven by a. pandemic, b. reopening, c. inflation…Once ABC is in place = rate hikes begin and the abovementioned liquidity supernova ends.
Breaking these down one by one:
- Pandemic: global COVID-19 cases up 50 million (20%) past 9 weeks on Omicron to H 300 million (Chart 3), deaths up ½ million (8%) to 5-6 million; both cases & deaths utterly dwarfed by 9.3 billion vaccinations (on pace to exceed 10 billion on Jan 27th); at the same time, bonds are trading “peak pandemic” where Hartnett notes that after 2 last peaks in COVID-19 cases 10-year yields jumped 50-60bps following 3 months.
- Reopening: “reopening” stocks outperformed “lockdown” stocks throughout Omicron (Chart 4 – note Moderna -60% from Delta variant highs). Two years later, consumers are now living with the virus – retail sales are up 22% above pre-COVID levels, yet payrolls remain 4mn below (Chart 5)
Inflation: this is the big one, and the one that has spooked Biden so much he has made it clear to the Fed it has to lower inflation. Here’s why: price of basic human needs such as food, heat, shelter soaring; global food prices up 27% YoY; US heating costs up 30% for natural gas, 43% for oil, 54% for propane; US rents up 12%, house prices 18% (Chart 6), lumber prices up 40% past 4 months…little wonder US wage growth up to 4.8% (Chart 7)
Going back to the topic of ending liquidity supernova, Hartnett reminds us that it is not deflation but rather inflation that causes recessions, and today’s inflation is caused by demand and supply bottlenecks and especially by central bank excess liquidity (which is why the Fed is hoping that by tightening or at least jawboning it, it can put the genie back in the bottle). But that won’t happen, and here’s why: COVID-era global central banks have bought $26bn assets every trading day (global equity market up $133bn every trading day). Which means that on inflation, central banks are way-behind-curve.
And as the liquidity supernova ends this year, QE goes from $8.5tn in 2020, to $2.0tn in 2021, to a negative $0.6tn in 2022.
The bursting of the liquidity supernova also means the bursting of the market bubble: As Hartnett notes, global negatively yielding debt is already down 40% to $11 trillion, with century bonds like those in Austria getting crushed…
And as goes credit, so goes everything else: the bubble in long duration tech, crypto, leverage assets simultaneously popping…
- HSTECH -51%,
- ARKK -45%,
- TAN – 42%,
- XBI -40%,
- XPD -37%,
- XBT -35%,
- FINX -29% from highs;
But surely the Fed will capitulate at some point.. so when to BTFD? According to Hartnett, the tradable bounce comes when BofA Bull & Bear Indicator breaches buy signal 2.0 level.
And while we have a ways to go as shown above, first we need to cross the coming….
Bear Market: according to the BofA CIO, the bear market risks are in biggest winners in QE-era…1. corporate bonds, 2. private equity, 3. tech stocks… as a reminder, the market cap of FAAMG is now >$10tn = 3rd largest “country” by GDP after US & China.
In terms of public equities, tech has been the biggest winner from pandemic as shown below. Indeed, since the onset of COVID market cap of Apple is up $2tn (to $3tn), bigger than Biden’s (failed) $1.75tn Build Back Better plan. Some more facts: Apple pre-tax income = $150bn, stock buybacks by Apple = $158bn, debt issued by Apple = $35bn at weighted-yield of 1.8% ($1bn was issued at 0% in 19), taxes paid by Apple to US government just $21bn; To Hartnett this means that the 3Rs of Rates, Redistribution, Regulation = sell Nasdaq.
What is remarkable is that we are already seeing deep selloffs (recall that more than 40% of the Nasdaq is down more than 50%)…
… and yet the Fed is yet to hike rates, Treasury yields remain in range.
So for those looking for actionable signals, keep an eye on credit, banks & brokers, and real estate which will indicate when the next round of financial conditions tightening is underway; here are some of the notable ones.
- 10Y TSY >1.8%,
- BKX <130,
- XBD <475,
- PSP <$14,
- XHB <$75
For a good example of turning points look at the chart below which shows the relative turn in China-US homebuliders – a sign of hawkish US policy, dovish China policy biting. Perhaps the best pair trade for 2022 will be going short US homebuilders (into a tightening environment) and going long China developers just as Beijing capitulates and is urging banks to boost lending to developers.
But while the Fed will surely hike and keep hiking until something breaks, Hartnett believes that a bigger 2022 test to credit/PE/tech is ECB hikes/end of BoJ YCC & end of EU/Asia capital flight to US stocks. While one ECB hike is priced-in, the BofA strategist believes that catalysts for faster rate hikes are French CPI>4% (post-Euro high), unemployment <7%, oil >$100/barrel. Similarly, the language during BoJ’s Jan 18th meeting is expected to hint at policy normalization (Japan PPI 9% Y/Y to pull CPI >2%).
And, as shown by the chart on top (recreated below), capital flows from Europe & Asia driven by ECB/BoJ policies of zero/negative rates has been boon to US/Nasdaq & US dollar…
… notably US tech has been favored more by global investors than US investors in recent Fund Manager Survey surveys; finally higher growth/rates in economies driven by bank lending (Japan/Europe) is a “flow test” to Hartnett that US tech fails in 22.
Finally, here are Hartnett’s favorite views & trades…
- Bearish: “rates shock” in ’22 to follow “inflation shock” of ’21; financial conditions to tighten sharply; asset prices driven by rates & profits…in “22 short rates rise, QE ends (inverted yield curve a threat) & EPS to slow sharply = -ve & volatile asset returns in ’22; correction catalyst Q1 = Omicron case count plummets
- Longs: 1. volatility, high quality, defensives on tighter financial condition; 2. oil, energy, real assets on inflation; 3. EAFE/EM banks on reopening; 4. Asia credit on distressed yield
- Shorts: 1. IG & HY bonds on Quantitative Tightening; 2. short private equity & broker dealers on wider credit spreads; 3. short Nasdaq on higher rates/less capital flow from Europe/Asia.
I’m on board with it. But with the end of Build Back Better, it’s not going to take long before we get reset to secular stagnation and MOAR.