One week ago, BofA chief investment strategist Michael Hartnett laid out his reasoning for why a market correction is imminent:
Fast forward to today when... nothing at all has happened, again: stocks are at new all time highs, the VIX is back to a whisker above 8, junk bonds issued by "emerging" countries with unpronouncable names are 5x oversubscribed, and complacency abounds despite the world being one tweet away from nuclear war.
There are two discrete reasons for this:
The first is that the great rotation - of bagholders - is in its final stretch as institutions dump in near record volume to retail investors. According to EPFR data cited by BofA, last week saw a "big" $11.6 billion in inflows to equities (largest since Jun’17), as well as $5.5bn into bonds, $0.4bn into gold. One caveat: it wasn't just institutions selling to retail (ie. the active to passive rotation) as last week also saw the first inflow into active funds after 10 weeks of outflows, amounting to $2 billion (chart 2) although Passive still remains king, with $9.6 billion into ETFs.
The second reason is that contrary to popular opinions, fighting the Fed is not only accepted, but extremely profitable. In fact, as Hartnett notes, the "Most Consensus Trade in the World' right now is "no fear of the Fed…Fed dots to 2019 = 2.7% vs 1.8% market-implied Fed Funds rate." The saying may go "don't fight the Fed" but fighting the Fed's dots has been the most profitable trade for the past 5 years.
To Hartnett this "lack of fear in the Fed" means that the Bubble in Yield (and stocks) will continue until investors, via inflation, begin to fear the Fed (& ECB…). Judging by bond yields, this is not happening: $0.98tn inflows into IG+EM debt funds past 10 years (Chart 3); this week sees 42nd consecutive week of IG bond fund inflows; inflows to EM debt funds 37 of past 38 weeks.
As an example of this fear manifesting itself, the BofA strategist reminds us of 1994: "Most obvious catalyst for sell-off is wage/inflation data that brings back “fear of Fed” in 1994-redux (“payroll” shock…Fed hikes 50bps…yields & MOVE index soared…risk assets tanked…until Orange County/Mexico defaults caused Fed to stop tightening – Chart 4); Sept 0.5% MoM AHE = stronger wage growth"
However, it's not just a sudden burst of inflation that can upset the cart, and according to BofA there are two other 11th hour catalysts that can lead to the "Humpty Dumpty scenario." Hartnett calls them "Tick Tocks" and they are both positioning related: in the first case, the BofA "Bull and Bear" indicator is just shy of hitting a "sell signal." This would be notable as the indicator's hit ratio is flawless, resulting in a selloff on 11 out of 11 previous cases, as follows:
The second "tick tock" reason is simpler: investors are about to run out of cash, which may come as a surprise to all those who still believe the "money on the sidelines" falacy.