The smartest guys in the room that have survived the last six months best are more not less bearish. BofA’s Michael Hartnett, who has been the maestro conductor of this crash, leads us off:
The Way We Were: “Millennials are quitting jobs to become crypto day traders”, USAToday, Aug 12th 2021.
The Biggest Picture: crash in crypto (Chart2)/speculative tech now rivals internet bubble crash (Nasdaq-73% peak-to-trough) & GFC (banks-78%); trading pattern of post-bubble assets always furious bear rallies amidst dead sideways trading range for couple of years.
The Price is Right: crypto implosion (COIN-90%, Terra-99% on combo of Nasdaq unwind, low liquidity, pool migration, whale attacks) exacerbates Wall St “fear &loathing”, fear of VC “marks”, PE collapse, bank loans breakdown (Chart3), dumping of Big Tech; good news for those expecting a bear bounce in the next few weeks…last of”crowded trades” short Japan yen & long commodities starting to unwind (Chart4), dollar not yet melting up into new territory (Chart).
The Tale of Tape: rally in bonds this week not (yet) coinciding with rally in biotech (below ’18 & ’20 lows), China credit (Chart6), EM, all of which were early “tells” of “rates shock”; GDP/EPS estimates to be cut in coming weeks (when banks down, yields up, no bueno…Chart7), but >25% of MSCI ACWI index now trading <10x forward PE.
Weekly Flows: exodus from Wall St…$1.8bn from gold, $6.2bn from equities(Chart 17),$11.4bn from bonds, $19.7bn from cash.
Credit vs Equity Capitulation: for every $100 of equity inflows since Jan’21, $4 has been redeemed; for every $100 of credit inflows since Apr’20, $25 has been redeemed; capitulation has progressed much further in credit than in equities…risk-on will appear first in bonds not stocks.
BofA Private Clients: $3.0tn AUM…63.4% stocks, 17.6% bonds, 11.8% cash (highest since Feb’21); GWIM cash % AUM not showing capitulation yet (Chart23).
BofA Bull & Bear Indicator: flat at 2.1 (Chart 1), has loitered here past 4-6 weeks aswe await sustained equity outflows, another uber-bearish BofA Fund Manager Survey.
Are We There Yet? No…fear & loathing suggest stocks prone to imminent bear market rally but we do not think ultimate lows have been reached, nor ultimate highs in yields; BofA “capitulation” checklist using today’s data vs COVID ’20, Euro-debt crisis ’12, GFC’09, tech bubble ’01 data @ lows (Table 2)…
1P vs 3Ps: bearish Positioning + Profit recession + Policy panic = Big Low for riskassets = new bull market; bearish PositioningwithoutProfitrecession + Policy panic =bear market rallies.
Policy Panic: global consumer inflation 6-12%, producer inflation 10-30%, highestpolicy rate in G7 = 1% (Table1), Fed yet to start QT…real policy rates terrifyinglynegative (a 250-year symbol of crashes,panics & wars–Chart 8); 0.4% monthly prints =end-year core CPI 6%, 0.2% monthly prints 4% (Chart 9)…big political problem (Chart10)= policy panic of 2022 is tighter not easierFed; contagious Wall St credit event and/or rise in unemployment can reverse Fed, at the earliest autumn; meanwhile fiscal policymaker desperation (see price controls announcement across US/Europe) & dollar debasement come first, both of which ironically will cause higher yields
20th vs 21stcentury: trailing PE for US stocks in 20thcentury averaged 14xvs 19x in21stcentury thus far; we believe secular inflation driven by trends in society (inequality),politics (populism/progressivism), geopolitics (war), society (inequality & inclusion),environment (net-zero), economy (end of globalization, demographics (China populationdecline) means higher inflation, rates & reversion of PE to norm (14-16x past 120 years–Chart11); why we think SPX 3600-3800 potential entry level, though likely undershoots (note average bear decline = 37.3% & avg duration = 289days (Table3) = today’s bear ends Oct 19th ’22 with S&P500 at 3000, Nasdaq at 10000…good news is bear markets quicker than bull markets (Table4).
At the Lows: best strategy to own will unquestionably be humiliated“60-40”strategy…strategy currently on course for worst return in 100 years (Chart 12–it’s mean return over this period has been 9%); in contrast 25/25/25/25 portfolio (equities/bonds/ cash/ commodities) just positive YTD (Chart13-albeit underperforming mean of7% return); humiliated“60-40”better bet than hubristic“25/25/25/25”once lows closerlater this year (Chart 14).
Morgan Stanley’s Michael Wilson has been almost as good:
The price is wrong
In our 2022year-ahead outlook for US equities, the primary out-of-consensus call centered on valuation. When we published it in mid-November, the price/earnings (P/E) multiple for the S&P 500 was 21.5x,a historical high ex the TMT bubble. However, the median P/E was actually higher than in the late 1990s. Furthermore, we believed at the time that earnings were well above trend and likely to revert over the next several years. If we were right, then valuations looked even more egregious. We argued that P/Es would fall toward 18x in our base case and 17x in our bear case as the Fed responded to 40-year highs in inflation – the “fire” in our scenario – while growth slowed from unsustainable levels – the “ice.”
Fast forward to today,and it’s fair to say we have achieved our de-rating targets, with the S&P 500 now trading at 17x. However,all of the multiple contraction to date has resulted from the Fed’s very aggressive path on tightening and the subsequent rise in 10-year yields. So, while the P/E is now close to our original bear case and our current base case, the equity risk premium (ERP) is very close to where it was in November. In short, we believe the rates market fully reflects the fire part of our narrative. In fact, rates could have overshot to the upside by incorporating more hikes than the Fed may be able to deliver in this cycle, based on the significant damage to financial asset prices and the approaching slowdown that looks much worse than just a few months ago. This sharper downturn stems from the conflict in Ukraine, the Covid-zero policy in China,and the Fed’s action itself, which has led to a significant rise in the cost of capital, including a 65% increase in 30-year fixed mortgage rates.
Turning back to the ERP, it has recently made some upward progress after the nearly inexplicable move to post-financial crisis lows over the past few months.
We attribute that overshoot on the downside to Russia’s unexpected invasion of Ukraine and the extension of China’s Covid-zero policy, both of which accelerated the flight to safety by global equity investors and asset allocators. With the S&P 500 viewed as the most defensive and liquid equity market in the world, it attracted flows like a magnet.
But over the last few weeks, it’s become clearer that our ice scenario is now playing out as well.For most of this year we have received strong pushback on our less bullish view on growth,until now. The change is due in part to the events noted above, but the real driver is 1Q earnings season.First, while most companies handily beat consensus EPS forecasts, the bar had been lowered during the quarter more than usual. Second, the ratio of negative to positive earnings revisions spiked. Third, the quality of the earnings deteriorated as incremental operating margins rolled over for many companies and sectors, including many important large-cap technology stocks.Finally,2Q estimates for the S&P 500 came down while full-year estimates were unchanged. This effectively raises the bar for the second half of the year, which is about the time the economy will be feeling the effects of higher rates and other headwinds.
Needless to say,earnings season raised some eyebrows among investors,and stocks sold off sharply in April – a seasonally strong month for equities. In the last week, P/Es contracted even further but this time due to the sharp rise in the ERP, while Treasury yields fell by less. This combination suggests the market’s focus has shifted to growth concerns – the ice – and quite frankly, it’s what we’ve been waiting for to call an end to this bear market. Unfortunately, while we think the equity markethas adjusted for higher interest rates, we’re justnot there yet with the ERP. At 300bp, ERP is well below our year-end 340bp target, and is underestimating earnings risk ahead. The question is will the equity market go ahead and discount the earnings cuts we think are coming or will it require companies to formally cut guidance? Given the pervasive bearishness now and extreme oversold conditions, we could see it play out either way.
The bottom line is that this bear market will not be over until either valuations fall to levels (14-15x) that discount the kind of earnings cuts we envision, or earnings estimates get cut. However, with valuations now more attractive,equity markets so oversold and rates potentially stabilizing below 3%, stocksappear to have begun another material bear market rally. After that, weremain confident that lower prices are still ahead. In S&P 500 terms we think that level is close to 3,400, which is where both valuation and technical support lie.
Yep. Finally, even smarter peeps inside Goldman Sachs are breaking with the permabullish brand:
GS May Capitulation Checklist (in order of speed of the unwind/selling): We have not capitulated, it is very slow on the way out
a) Fundamental Hedge Fund Exposure (zeroth percentile rank) ✓
b) Systematic non-fundamental Exposure (net short) ✓
c) Discretionary Macro “short for a trade” ✓
d) Mutual Fund Cash Positive is elevated ✓
e) Retail trader below 2020 levels and out ✓ (Full deep dive on where those YOLO traders are now (performance/share volume/ option volume)
f) US Household / Retirement Accounts (**NOT CHECKED** Tracking this cohort is my single and most important focus from the lows here)
a. What is the average entry price of >$1 Trillion worth of equity inflows?
b. Who owns the largest amount of equities from here?
c. What level of drawdown is typical to start the outflow process?
d. What impact can passive redemptions on the equity tape given the liquidity environment?
e. What we are watching for the close each day (S&P 500 imbalances @ 3:50pm and NDX imbalances @ 3:55pm)
Does that last chart look like equities capitulation to you?
MB Fund remains very underweight equities. Moderately long bonds and accumulating. Very long cash, most notably USD.