BANK OF AMERICA: A ‘summer pain trade’ is coming for investors with a rosy view of the global economy

BANK OF AMERICA: A ‘summer pain trade’ is coming for investors with a rosy view of the global economy

Bank of America Merrill Lynch is telling its super-rich clients to get ready to sell any stock market rallies this summer.

Michael Hartnett, BAML’s chief investment strategist, has referred to these investors as the “thundering herd” as he’s identified a number of shaky trades they’ve all piled into. A “summer pain trade” is lined up, he said.

BAML’s wealth-management division manages $2.35 trillion of their assets.

“Private clients still believe in higher growth and a “good” rise in rates; we believe both views will be challenged in autumn by higher wage growth & Asian economic slowdown,” Michael Hartnett, BAML’s chief investment strategist, said in a note on Thursday.

Hartnett previously wrote that this market environment reminded him of 1998, when a credit crisis in Asia forced investors who who had big positions in the region to raise cash by selling en masse.

The so-called Thundering Herd has piled into other positions that Hartnett is watching closely. Here are a few:

  • They’re allocated 61% to stocks, just below the record share of 62.5% recorded in March 2015. But cash levels are near a record low of 10%.
  • They’re confident that the global economy still has room to grow. In turn, 43% of their assets in BAML’s custody has flowed into Europe, Australiasia and Far East stock funds, versus 9% to US funds.
  • Their allocation in stocks has “shifted down in quality.” The one-year beta of their top-20 holdings, dominated by financial, energy, and tech stocks, is at a record high of 1.10. A beta greater than 1 indicates that the stocks in question are more volatile than the S&P 500.
  • They’ve moved “up in quality” in rates. BAML’s private clients have collectively put 2.3% of their assets into Treasury bills, a 10-year high.

Added to these trends is the fact that the firm’s Bull & Bear Indicator has veered into “extreme bearish” territory, at 2.3 on a scale of 0 to 10. It’s normally a contrarian indicator, but BAML’s quant and equity strategists say there are longer-term reasons for caution on stocks.

Also, several bear-market signposts that BAML is watching have been triggered — 14 out of 19, to be exact.

The quant and equity strategists ticked off the most recent one this week, after they observed that low-quality stocks — companies with the highest debt and weakest profitability — are outperforming high-quality ones. Also, active managers’ exposure to low-quality stocks relative to the broader S&P 500 is near a record level.

There’s a big signpost that’s yet to be triggered: a yield curve inversion, when the 10-year note’s yield rises above the two-year’s. Also, BAML’s equity strategists still maintain a year-end target of 3,000, implying the market will rise about 7% from current levels.

But if Hartnett’s observations are correct, it may be time to brace for some pain this summer.

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