Global Research
The Flow Show
02 February 2018
Key takeaways
· Sell signal triggered: BofAML Bull & Bear Indicator surges to 8.6
· Tactical S&P 500 target: we forecast a decline to 2686 by end-Q1
· Client feedback: would rather play rotation than reversal
Talking Points
Hot January: S&P 500 bull market became 2nd largest of all time last Friday (@ 2873), global equity market cap of $86.6tn up $57.9tn from 2009 lows and $29.9tn from 2016 lows.
Hot Flows: massive $25.7bn into equities this week (Chart 2), $5.7bn into bonds; remarkable $102bn into equities YTD; rotation into equities, out of Treasuries & HY bonds currently fastest pace of Great Rotation on record.
Sell: BofAML Bull & Bear Indicator surges from 7.9 to 8.6, triggering contrarian sell signal for risk assets (Chart 1); signal triggered on Jan 30th via record equity inflows, bullish hedge fund risk appetite (CTFC data), global equity index breadth >1SD.
Q1 Reversal: per last week we forecast decline in S&P500 to 2686 by end-Q1; Bull & Bear indicator sell signal hit ratio = 11/11 since 2002; avg equity peak-to-trough decline = 12% (following 3 months), avg decline in 10-year Treasury yields = 58bp (link for indicator composition & full backtest results).
Clients position for Rotation not Reversal: YTD flows show stubborn bid in secular deflationary leadership ($35.4bn to IG & EM Credit, $5.7bn to Tech - record 4 weeks) but also new desire to chase inflation or weak dollar laggard plays (past 4 weeks $12.5bn into Japan equities, $3.6bn to Financials, record $4.4bn into TIPS, record $24.4bn to EM equities. BofAML Emerging Market trading rule "sell" signal triggered this week as EM equity inflows >1.8% AUM past 4 weeks, hit ratio 11/18 since 2004 (link).PX <2600: catalysts for deeper correction...consensus stunned by February of weaker macro, weaker stocks, lower yields, stronger dollar; surge in wage growth causes spike in Fed hike expectations; we think "bond shock" too consensus and EPS shock (Chart 3), credit shock, dollar shock more likely catalysts for cross-asset vol spike.
SPX <2600: catalysts for deeper correction...surge in wages (eg Jan AHE >0.4%) causes spike in Treasury vol (MOVE index); but since all worried "bond shock" bigger surprise would be Feb of weaker macro, stronger dollar, lower yields (nb weakness in US homebuilders XHB early sign rates starting to bite).
SPX >3000: catalysts for no correction…a speculative equity overshoot has begun driven by central bank liquidity supernova (BoJ expanded QE this week) and rotation out of $10.8tn of -ve yielding global debt, suggesting we have entered a 2SD world, no longer a 1SD world, making sentiment signals less relevant.
Client feedback (Asia): "too early for a tradable correction...pullback 2-3% max which will be bought...macro & investment backdrop too perfect to sell...come back when yields & inflation punitively above 3% and SPX above 3000...rotation to Japan, China, Europe more tempting than US reversal...wait for top in laggard China banks to signal global top…we only just got bullish!".
Michael Hartnett
Chief Investment Strategist
MLPF&S
+1 646 855 1508
This report is intended for Alexandra Fletcher