We’re almost there: in just 4 trading days, the S&P 500 “bull market” which has purchased by central banks with trillions in liquidity and by companies with even more trillions in buybacks, will become longest of all-time.

And yet away from the S&P, BofA’s Michael Hartnett notes that “there have been so many grizzly bond, commodity & equity market returns this year”: for example, global bonds are annualizing their worst price return (-3.5% local currency) since 1999; 11 of 21 commodity markets have experienced “bear” markets; 1254 ACWI constituents out of a universe of 2273 are in bear markets (i.e. down >20%).

Just as ironically, less than a month after the record bull run anniversary comes September 15th, which marks the 10-year anniversary of Lehman bankruptcy & Global Financial Crisis; what happened next is precisely why the bull market is about to be longest in history:

central banks immediately adopted extreme & unprecedented monetary policies (705 rate cuts, $12.4tn QE, lowest global rates in 5000 years) successfully preventing debt default & deflation, reflating Wall St…catalyzing one of the greatest credit & equity bull markets in history.

Meanwhile, just as fascinating are all the assets that 10 years later actually remain below their Sept 14th 2008 levels…oil, industrial metals, equity markets in Italy, Spain, Russia, Brazil, Turkey, global equity sectors such as energy & utilities, and most glaring of all, the European & the Japanese banks; the central banks prevented debt deflation, but they did not inflate indebted assets.

And while the S&P has so far been spared, “the end of the excess liquidity regime in 2018 has been the main factor behind the grizzly bond, commodity & equity market returns this year” (with the very conspicuous exception of the US dollar, the NASDAQ & the S&P500):

  • YTD global returns of US dollar 5%, commodities 2%, stocks 1%, cash 1%, high yield -1%, government bonds -2%, investment grade -3%…truly disappointing given global synchronized recovery, multi-decade unemployment lows in US, UK, Japan, Germany, 4% US GDP growth, record global EPS, $1tn US stock buybacks, $1.5tn US tax cuts
  • Global bonds (as measured by the $51tn ICE BofAML global fixed income index) are annualizing their worst price return (-3.5% local currency) since 1999
  • 11 of 21 commodity markets have experienced “bear” markets (i.e. >20% peak-to-trough decline) and a further 9 “corrections” (i.e. >10% peak-to-trough declines)
  • 12 of 45 MSCI country indices are in “bear” markets and a further 17 equity indices have experienced “corrections”
  • The MSCI World Index (equal-weighted) is down 14% since its Jan highs (Chart 3); 1254 ACWI constituents out of a universe of 2273 are in bear markets (i.e. down >20%)
  • And the S&P500 summer surge had been unambiguously led by defensives (top 5 performing US sectors past 3 months = staples, utilities, REITs, health care, telecoms, in that order)

Yet even as the S&P has managed to decouple from the rest of the world, the clouds are gathering as the stealth bear market of 2018 threatens to spillover into the US.

Here Bank of America once again resorts to the 3P – Positioning, Profits, Policy – that dictate tactical and cyclical shifts in credit & equity markets.

Of the three, Positioning is the #1 positive for risk assets according to Hartnett. In January, BofA’s Bull & Bear Indicator hit 8.6 indicating a “euphoric” market; in contrast by June the same indicator was signaling very-close-to-but-not-quite-Despair, having dropped to 2.3.

Currently we are only marginally above (3.0) the “extreme bear” levels, hence our view that summer “pain trade” was up. Sadly contrarian upside has been limited to the market with the buybacks: the US.

At the same time, thanks to Trump tax reform, corporate profits have surged in 2018: 23% in the US, 10% in the rest of the world. However, corporate bonds & equities have played “buy-the-rumor, sell-the-fact” with EPS in 2018 and in recent months lead indicators of global profits, such as Korean exports (note Japanese export growth negative in July in the chart below)…

… European & Chinese PMIs, and global trade volumes…

confirm that global economic momentum & profit growth peaked in March.

Meanwhile, the US yield curve is now <25bps from inversion (has signaled 7 out of past 7 recessions). We suspect the weak US housing market portends a shift in the US macro narrative to peak US GDP, yields & US dollar in the next 3-6 months.

At the same time, there is a growing need political and social need to transition from QE to PE (“Populist Easing” via Keynesianism, Redistribution, and Protectionism) which is already proving less asset-price friendly. This trend is likely to worsen as politicians voice support for central bank subservience, Occupy Silicon Valley policies, and regulation/taxation of stock buybacks in the name of wealth inequality.

And of course monetary policy stimulus has also peaked: Central bank asset purchases were $1.60tn in 2016, $2.30tn in 2017, but are just $0.16tn thus far in 2018, and by year-end global liquidity will be contracting.

The imminent contraction of global liquidity has already been sniffed out by the “canary-in-the-coalmine” asset class of Emerging Markets. Picking up on what SocGen noted three weeks ago, when it highlighted a “near unprecedented” divergence in the FX market between EMs and Developed Markets, BofA shows that EM volatility relative to G7 FX vol is now at a 10 year high.

What happens when EMs finally crack, with or without the developed markets: according to BofA, “ultimately, the Fed will work out that a levered financial market and economy can’t cope with higher rates and they will stop“:

Share buybacks with borrowed money is leverage, private equity are leveraged equity portfolios, tax cuts financed with Treasuries is leverage, pension fund liabilities in excess of assets is leverage

Ultimately, a cynical if accurate argument for financial assets is simply that “US policy makers cannot take the risk of letting asset prices cause a recession”: US financial asset prices as a share of US GDP are now at a record high.

And since Wall St deflation, rather than Main St inflation, is the quickest route to recession, the Fed will have no choice but to prop up markets once more.

The question is when… here is BofA’s forecast:

Until the Fed blinks (likely December at the earliest) and until KOSPI & copper indicate that Chinese policy makers have eased big to stimulate Asian growth, we believe the double-whammy of Peak Profits & Peak Policy stimulus will overwhelm Bearish Positioning; we retain defensive, bearish recommendations.

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