Hartnett: Short Stocks Until Halloween, Then Brace For The Rally
Earlier today, we quoted Bloomberg strategist Simon White who agreed with us - and with BofA's Michael Hartnett and Morgan Stanley's Mike Wilson - saying that the lack of a spike in the VIX, alongside the Fed now being well into its hiking cycle, suggests that "it believes the Fed put is getting nearer. Certainly, current oversold conditions suggest a short-term bounce is at hand."
But while generally accurate, even White's assessment was rather vague. Instead, for a much more definitive take we once again go to the man who remarkably has called every reversal in the market (in the case of the latest bear market bounce, to within half a tick in spoos) and in his latest must read Flow Show note Hartnett describes in which the selling continues for another 45 or so days, then we bounce hard following a coordinated G20 intervention... and then tumble again when we hit the "big low" in Q1 where the recession and credit shocks force Powell and the Fed into a full-blown pivot panic.
Here is Hartnett's "tactical bear" tiemline for the next 6 months: “short twos (2Y TSYs) & spoos” until Halloween, when the S&P plunging to 3333 will force “policy panic” just in time for the Nov 16th G20 meeting, at which point stocks rally... but the “Big Low” will not hit until Q1 when recession/credit shocks = “peak Fed”, “peak yields”, “peak US$”; at that point Hartnett's "trade of 2023" kicks in which, as a reminder, is short $, long EM, small cap, cyclicals.
And, as before, Hartnett's macro trade reco is simple enough: "nibble 3600, bite 3300, gorge 3000."
That's the quantitative aspect, the qualitative aspect is also familiar enough to anyone who has been reading Hartnett in recent year, and it all boils down to the simple maxim: "Markets stop panicking when Central Banks start panicking" and while we have had an appetizer of what is coming, the big central bank entree still awaits, to wit: "BoJ buys yen, BoE flips from QT to QE = panic, but neither credible (BoE QE + tax cuts = inflation, BoJ YCC), nor coordinated, so impotent." What is needed for a credible pivot? Well as the word itself suggests "Fed/Treasury panic requires US credit event."
Having revealed his medium- and longer-term views, Hartnett then turns to the near-term where he sees mostly pain as the last pillar of NYSE composite support crumbles:
The Biggest Picture: NYSE Composite (US stocks, ADRs. Bond ETFs) breaks 14k = 200-week MA, ‘18 & ‘20 highs...Wall St losses now forcing liquidation.
Ironically, investors already took the hint, judging by the latest weekly flows:
- Inflows $7.6bn to equities, outflows $1.4bn from gold (14th week, longest streak since Jan’14), $13.7bn from bonds, $52.8bn from cash (quarter-end).
- Flows to Know: a. UK equity outflows on pace for worst year ever ($18bn); b. biggest outflow from IG/HY/EM debt debt in 13 weeks ($13.7bn); c. largest outflow from TIPS since May’22 ($1.9bn).
- BofA Private Clients: $2.8tn AUM...61.1% stocks, 19.8% bonds, 12.0% cash; 31st week of private client inflows to bonds (note 2-year Treasuries yielding 240bps more than S&P500 dividend yield); GWIM ETFs...into staples, out of MLP, materials, gold.
What about the time-tested BofA Bull & Bear Indicator, which remains at a 0.0 max bearish reading amid deteriorating bond flows, credit technicals, it's been here for about 4 months now, wasn't it supposed to be a “contrarian buy”? Well, as Hartnett explains, the answer is no - as in 2008 - when a 2-sigma credit event is brewing.
Hartnett next takes readers on a brief chronological ride through his investment thesis that defined late 2021 and most of 2022, and which was proven 100% accurate:
2022 in a Nut: inflation shock caused rates shock which now threaten recession shock & credit event; Wall St disorder in 2022 reflects painful regime change as bullish deflationary era of peace, globalization, fiscal discipline, QE, zero rates, low taxes, inequality gives way to inflationary era of war, nationalism, fiscal panic, QT, high rates, high taxes, inclusion.
The biggest catalyst for the tradition to a recession shock and credit event, is central banks going Cold Turkey: there have been 294 global rate hikes since Aug 2021 vs 1302 rate cuts since Lehman. More remarkable is that in the past 7 months there has been QT of $3.1tn (contrast with Fed/ECB/BoJ/BoE QE liquidity buying of $11tn during COVID);
This tsunami of rate hikes and QT shock have hit Wall Street's addiction to liquidity: not surprisingly, the global stock & bond market cap has cold-turkey collapsed $46.1tn since Nov'21!
And it's going to get even worse: picking up on another of his favorite themes, Hartnett warns that war is always Inflationary; indeed the war is what caused the latest fiscal panic: UK + EU have announced $1.4tn of fiscal stimulus to ease energy shock and build military; this only exacerbates the trend of higher inflation & yields as this week's BOE pivot showed; see UK inflation & yields during WW1 & WW2...
... and asset performance during geopolitical events past 70 years.
And speaking of central bank intervention during times of war - this may come as a surprise to many - the Fed started the original Yield Curve Control just 4 months after Pearl Harbor (April’42) to help fund war and keep interest rates flat. Expect no less during this war.
* * *
Hartnett next refreshes readers on a topic he has covered at length in recent months, namely the parameters and history of Bear Markets: some context: the S&P 500 is in the 20th bear market over the past 140 years, where the average peak to trough decline is 37.3%, and average duration 289 days (Table 2);
Repeating what he said back in May, Hartnett then observes that while history no guide to the future, "history says bear market ends Oct 19th 2022 (35th anniversary Black Monday) with S&P 500 @ 3020."
Then again, that may prove an optimistic take, because as Hartnett himself acknowledges, rates are now higher than in the 2018 meltdown, while LQD, HYG, ACWX, EEM, LQD, EMB are all below 2018 lows; At the same time, far, far from 2018 lows are US stocks, big Tech, private equity.
On the other hand, we are nearing the "Oversold Entry Level" : by this, Hartnett means that in the past 100 years, buying at -20% below the 200dma was a good entry point back into stocks (today that would be 3374... which also happens to be the pre-COVID 2020 high)...
... and while this has worked almost always, there have been a few clear exceptions: the 1931 depression, 1937 Fed policy mistake, 1974 stagflation, 2008 GFC; In other words, a monster undershoot requires monster credit event & recession (Chart 4, Table 1).
But while the Fed will inevitably overshoot in the opposite direction as they always do, there is another far bigger problem: the entire modern financial system is busted, a topic Hartnett covers in "The Modern Prometheus" - consider the record surge in bids accepted for NY Fed's overnight reverse repos, from $0 in Feb '21 to $2.4tn
This, as Hartnett himself writes, "reflects broken, freaky post-QE financial system plumbing, and ’22 fear, manifesting in US dollar shortage, 2-year swap volatility exploding - as we noted yesterday, we just saw a collapse in 2Y USD swap spreads...
... while at the same time, € rates volatility has quietly surged above GFC highs...
... which leaves us with the following potential credit events to end monetary tightening:
- government debt (UK, Japan)
- household debt (Australia, NZ, Canada, Sweden)
- 2024 refinancing cycle for US corporations
- US shadow banking exposures to credit
- syndicates loans,
- illiquid PE (the new “too big to fail”)
- real estate
Hartnett concludes with his latest take on asset allocation and Expected Returns: the issue is that neither has yet to experience “regime change”; after all, asset allocation to stocks remains high by historic standards (e.g. private client allocation = 62% vs lows of GFC 39%, US debt debacle 54%, China deval 56%, COVID 54%; This means that without a big adjustment lower in equity exposure (it’s already happened in credit exposure) it would be tough for expected returns to get anywhere near historic annual 10%, let alone 14% seen past decade...
... and while the market story of 2023 won’t be downside, Hartnett expects more limited upside from risk assets.
