Back in mid-July, Bank of America chief investment strategist Michael Hartnett wrote “The Most Dangerous Moment For Markets Will Come In 3 Or 4 Months” in which he warned that “further upside in risk assets will create problems later in the year” and concluded that “ultimately, we believe the extremely strong performance by equities and bonds in H1 is very unlikely to be repeated in H2” because “monetary policy will have to tighten to raise volatility, reduce Wall St inflation, and reduce inequality. There are two ways to cure inequality: you can make the poor richer, or you can make the rich poorer. The Fed will reduce its balance sheet in the hope of making Wall St poorer.”
Or maybe not, because almost three months later, the same Hartnett today writes that the “best reason to be bearish is…there is no reason to be bearish.” and admits that the “Icarus ‘long risk’ trade extended into autumn (Humpty-Dumpty “great fall” postponed a tad longer) by low inflation, big liquidity ($2.0tn central bank buying), high EPS, and promise of US tax reform”, noting that the “monster rally in credit and equity markets began 18 months ago when best reason to be bullish was there was no reason to be bullish.”
And with the VIX approaching all time lows as the S&P hits another daily high, the BofA strategist reiterates that his “Icarus Rally” price targets for Q4 remains 2630 in the S&P, 6666 on the Nasdaq, and the 10-year Treasury hitting 2.85%, as the rising dollar pushed the EURUSD down to 1.15. So what will prompt Q4 peak in the market? According to the BofA strategist, the catalyst will be a “Q4 “top” driven by tax reform, i.e. “peak Policy, a rise in MOVE index, and a peak RMB.
As Hartnett details further, here are the three catalysts that could end the current period of record complacency. Tax reform = “peak policy” = buy rumor, sell fact…but too early to sell fact; tax reform = quicker Fed balance sheet reduction and less share buybacks if capex accelerates (since 2009 lows S&P equity market cap up $15.3tn, Fed’s balance sheet up $4.5tn, share buybacks up $3.5tn) Big jump in the MOVE index of US Treasury market volatility (i.e. “bond shock”) catalyst for cross-asset vol, but requires inflation to rise
This post was published at Zero Hedge on Sep 29, 2017.