When it comes to what happens next in the stock market, few have their bases covered quite as well as Bank of America, which is bearish, neutral and super bullish at the same time.
Recall, last week we reported on Savita Subramanian’s latest research report, which “called the top” for the US stock market this year, saying the bank’s year-end target is 2,900 “even though our Sell Side Indicator yields a bullish target of 3069, the rest of our signals temper that signal.”
Then today, BofA also the downside base when its credit strategist Carol Zhang wrote that with the overall direction of U.S. economy now heading lower, “we think markets are still not fully pricing in the decelerating growth momentum,” noting that pessimism has grown since the beginning of August, with weaker economic data, pullback in CEO expectations and even more pessimistic Fed outlook.
However, just to make sure it has all bases covered, overnight BofA Chief Investment Strategist Michael Hartnett also decided to “predict” the hail mary case in which stocks explode higher, largely – if not exclusively – due to one reason: the Fed.
As Hartnett makes clear, its not just the past decade that has been a direct function of the Fed’s intervention in markets – the Fed’s all too visible hand is obvious across the past 50 years! According to Hartnett, who paraphrases a certain politician saying “It’s the Fed, stupid”, strong 2019 returns have been driven by the Fed easing & bond bubble; to those surprised, Hartnett points out the 1968-76 period of Vietnam, end of Bretton Woods, credit events, oil shock, Nixon impeachment – just like now, so then the Dow Jones slavishly followed path of Fed policy, as easing caused rallies, and tightening caused corrections.
Of course, it’s not all smooth sailing, and as we approach year end, in addition to the Fed, investors have to consider the Joker: IPOs -12.6%, broker-dealers -5.3%, CCC HY bonds -1.1%, leveraged loan ETF -1.9% past 3-months. To Hartnett, all this indicates “cracks appearing in crucial liquidity & credit leadership.”
Yet none of that matters in the context of the “Irrational Contagion” prompted by central banks: to be sure, central bank balance sheets – now at $16.1 trillion – are rising again as the Fed just restarted “NOT A QE” and the ECB restarted QE…
… and this combination of extreme liquidity policies and bearish investors keep BoFA “contrarian bullish” – as we noted two week s ago – into 2020. Hartnett’s rather whimsical conclusion:
if Greece can successfully auction negative-yielding T-bills, we see no reason why the S&P500 bull market that started at 666 couldn’t end with an overshoot to 3333.
To justify his “irrationally” overshooting target – especially in the context of his colleagues’ bearishness – Hartnett lays out 5 key reasons:
- “Irrational contagion”: we are “irrationally bullish” driven by bearish positioning, desperate liquidity easing, and “irrational contagion” from bond bubble to equities; Greece auctioned negatively yielding T-bills, US auctioned record low-yielding (2.17%) 30-year government bonds this week…bond bubble delays global recession and encourages irrational contagion to stocks; in our view there’s no reason SPX can’t overshoot to 3333 next year (perhaps peaking around “Super Tuesday” on March 3rd) completing its extraordinary 11-year bull market from the 666 lows. (Chart 3).
- Rates, Recession & Rotation: investor concerns over rates, recession, rotation may be realized in 2020 but in coming months we take a contrarian view on all three.
- Rates: “flight-to-quality” in credit markets (Chart 5) rarely a positive sign for stocks; but Fed repo QE just beginning, ECB QE yet to start; and yield curves have quietly started to steepen, which should lessen EPS anxiety.
- Recession: BofAML Global EPS Model falls from -6.5% to -7.1% on weak Sept Taiwan export growth…consensus global EPS forecast for next 12 months is -3.3% (Chart 6); EPS in recession already but…key driver Asia exports will likely flip v positive YoY in Nov/Dec on base effects, G3 capital goods orders showing signs of a trough, dramatic decline in rates & oil boosting global financial conditions.
- Rotation: since 1926 there have been 5 occasions when US growth stocks outperformed value by 30 percentage points in 2-year period, each occurring shortly before recession or war; this is the 6th occasion (Chart 7) and another unambiguous warning sign for 2020; but again near-term value can counter-rally as peak US$ on trade deal spurs contrarian trade into commodities, Asia, EM & cyclicals.