Bank Of America: “This Is A Sign Of Irrational Exuberance”
Two weeks ago, when discussing a recent Albert Edwards piece, we said that the word that has come to define the new normal better than all others, is “paradox“, as in nothing makes sense, or rather everything makes sense if one only flips logic and reason 180 degrees. A “paradox” was on full display in the latest Bank of America Fund Managers Survey which found that once again, the percentage of respondents saying equities are overvalued hit a new record high of 45%; and yet the average cash levels continue to fall as one professional after another – whose year end bonus depends on whether they outperform the market – rush to allocate funds to equities, which most now agree are an asset bubble.
And while we call this “paradox”, Bank of America has another, more familiar name for the phenomenon: “this is a sign of ‘irrational exuberance’.“
Yet while breakneck allocation to stocks continues apace, there has been notable rotation within the sector, and as the next chart shows, the November rotation shows buying of cyclicals and value, and selling of 2017 winners such as EM, Japan, Tech. It is unclear what is going on in December when everything appears to be bought.
Also of note: the tech sector allocation appears to be rapidly declining, and in December fell to 24% overweight, “the long-term average and the lowest z-score for tech in 3½ years.”
But while the “growth” narrative may be fading for now, Goldilocks remains the consensus view for the global economy, with 54% of investors surveyed expecting above-trend growth and below-trend inflation in the next 12 months, just 2% lower than last month’s record high. As BofA adds, “Goldilocks is now the consensus view for the global economic outlook” while the “below-trend growth/ inflation” outlook rose 2ppt to 27%, close to May’11 lows & a total reversal from Jun’16.
Meanwhile, the yield curve reaches its flattest levels since the GFC as net 0% investors say they don’t need fiscal stimulus, the highest since 2011.
And speaking of the yield curve, net 8% of investors surveyed expect the U.S. yield curve to flatten in 2018, the highest level in 18 months
Separately, as reported earlier, “Long Bitcoin” is again considered the most crowded trade (32%) for the second time this year, followed by Long FAANG+BAT (29%) and Short volatility (14%)
As also noted, a central bank error, i.e. “policy mistake” by the Fed/ECB continues to be the top tail risk cited by investors (23%); the top three are rounded out by a crash in global bond markets (15%) and a Chinese debt crisis (14%)
When asked about the consequences of the GOP tax bill, a whopping two-thirds of respondents, a stunning consensus for this survey, expect tax reform to result in higher bond yields and higher stocks, while only 3% think tax reform will lead to lower yields and lower stocks.
Also, just 7% of investors say global interest rates will be lower in the next 12 months; 77% say interest rates will rise.
Translation: one year from now stocks and yields will be far lower.
Also, in December global investors favored banks, technology, industrials, insurance and discretionary while avoiding staples, telecoms and utilities. Which means the contrarians should do the opposite.
Here is how Michael Hartnett summarizes the big picture themes from the December FMS:
- Golditrumps: consensus still smitten by Goldilocks…54% expect “high growth, low inflation” in 2018. Almost 2/3 investors believe US tax reform will induce higher stocks & rates, but fiscal stimulus has coincided with lower, not higher profit expectations, and that will need to change given EPS leads relative performance of cyclicals by 3 months (Exhibit 10).
- Pro-cyclical Consensus: Investors are long macro “boom”, short “bust”; long stocks, EU/Japan/EM stocks, financials (2nd largest ever), materials (highest since 2/2012) vs short government bonds, US stocks, healthcare & utilities. Pro-cyclical consensus entrenched by US tax reform across asset classes, bar, intriguingly, leading tech sector where allocations dropped to lowest since June 2014.
- FMS Crowded Trades: …#1 long Bitcoin (32%), #2 long FAANG+BAT (29%), #3 short volatility (14%), while expectations for a “flatter yield curve” surged (highest in 18 months), all trades vulnerable to higher inflation & aggressive ECB/BoJ Quantitative Tightening in 2018.
- Contrarian Recession Trades: …a recessionary bust even more contrarian than inflationary boom, lower rates more contrarian than higher rates, making short equities-long bonds, short banks-long utilities, short EAFE-long US stocks the most contrarian trades of all heading into the new year.
Finally, when asked when this bubble finally ends, investors were split on the expected timing of equity markets peaking in 2018: 25% see a peak in Q1, 30% in Q2, and 28% in the second half of the year