Buy stocks; that’s the simple message of an investment strategy research note sent out by Bank of America’s chief investment strategist Michael Hartnett to clients earlier this week.
Hartnett’s simple bullish message is based on the pessimistic attitude of investors in the market following Brexit and amid the general global economic malaise. Indeed, according to Bank of America’s research, investors ended June with the highest cash allocation on record at 5.7% on average and reported the lowest equity allocations in four years. Moreover, it looks as if investors are capitulating into bonds with annualised year-to-date return from global government bonds in 2016 at 25%, the highest return in 30 years. These three bearish indicators combined with the fact that inflows into precious metal funds hit a record during the first week of July, all point to the fact that investors are very bearish on the outlook for global equities. Bank of America, Merrill Lynch’s Bull & Bear Indicator, fell to an “extreme bear” reading of 1.6 on June 28.
Since the end of June, however, it seems that investors have reversed course. Harnett highlights that recent days have seen the largest inflows to US equity funds since 2015, and Monday saw the biggest inflows into high yield bond funds ever.
It’s time to buy stocks
This sudden change in investor sentiment has a lot to do with the “Black Swan” event playbook that has become so familiar in recent quarters. The China devaluation in August, the Third Avenue high yield event in December and the oil crash in February all induced a “flash crash” in asset prices and a “growth scare” for the economy but were soothed by central bank policy and markets soon recovered. This time around the playbook hasn’t been any different. Harnett writes:
“Thus BREXIT has, at least initially, acted as another “mini-LTCM-event”: exogenous shock, policy reaction, limited macro fallout, melt-up in core bull trends…which in 2016 means any asset that provides the scarce characteristics of “growth”, “quality” & “yield”. Incited by the belief that every single interest rate in the world is heading to zero, the current Mountain of Cash on the sidelines has induced fresh “irrational upside” in government and corporate bonds (IG & HY), high quality and high yield stocks (e.g. REITs and staples stocks are at all-time highs; utilities and telecom are near their highs) and populist policy inflation-hedges (EM, silver, gold), as the current “speculative frenzy” in bonds mutates across credit, commodity and equity markets.” — Michael Hartnett
Unfortunately, this melt up can’t last forever. Harnett goes on to speculate that at some point in the near future a liquidity induced rising asset prices could cause inflation in the real economy, leading to monetary tightening. The resulting spike in bond prices yields could prick the bubble in financial assets.