When surveying the hedge fund positioning landscape, Michael Hartnett, global chief investment strategist at Bank of America Merrill Lynch, might see sheep lining up on their knees worshiping at the altar of zero or negative interest rate policy.  In a Global Fund Manager Survey, the bank observes that ZIRP winners are a crowded trade as the unprecedented economic actions might be set to experience a documented heightened degree of sensitivity. Like Bridgewater Associates and Goldman Sachs, BAML is watching “vulnerability to a bond Financial Shock .” In other words, the crowded followers on their knees have potential to get slaughtered Wall Street style, particularly if interest rates ” Financial Shock.”

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Financial Shock

Financial Shock - Understanding what is behind market "sensitivity" are important to accurate analysis

To a degree, Wall Street code words are similar. When an analyst warns of “price sensitivity” it sends a message of potential volatility to the knowledgeable. More recently, certain analysts have pointed to a market from bonds to stocks that have been transfixed by central bank policy, both overt and, although documentable if true, certain policies generally not discussed in public.

For investors accurately understanding the performance drivers is meaningful relative to reasonably logical price modeling and market analysis.

BAML, for its part, didn’t dive into the politically correct waters that can be central bank central planner monetary policy. Instead, the report notes that interest rates are subject to “shock” and observe that developed market bond prices are “frothy.”

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Financial Shock - When values are "frothy" the supply and demand balance is unnatural

Fully 82% of institutional investors participating in the bank’s Global Fund Manager Survey described US Treasuries as overpriced, or “frothy.” This group, which thinks the Bank of Japan and European Central Bank is going to maintain a negative interest rate stance for the next 12 months, see US Treasuries as the driver of stocks for the next six months.

The importance of Treasuries comes as the Federal Reserve is set to hike interest rates a second time in nearly one year. Janet Yellen’s Fed will shock investors if they raise rates in October, which will be announced Wednesday. The leading consideration for the next “shock” is December, but certain independent analysts are whispering the wisdom of a January or February rate hike near the inauguration of a new US President.

It is in this environment that BAML’s note on the crowded negative or zero interest rate stock winners becomes material, particularly depending on the bond’s geographic orientation. Bonds in a rising rate environment might find a higher rate of change than those in regions where interest rates are not rising.

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Financial Shock - 42% of fund managers negative as bond yields are seen as driving stock market returns over the next six months

As the US election approaches, 42% of fund managers in the BAML survey say they have a bearish view on markets, while close to 20% have a preference for low-yielding alternatives to cash.

The negative interest rate winners, mostly high-quality stocks, earnings-rich corporations, particularly corporate bonds like those that qualify for the ECB’s bond-buying program, are those where investors might wish to start considering potential trend reversal.

Looking at fund positioning, those sectors currently in vogue include emerging markets, industrials, cash, discretionary, bank and insurance stocks. The short side of exposure momentum includes the US, equities, consumer staples Japan, utilities and beaten-up Pharma.

When looking at the primary performance drivers in the stock market, Treasury bond yields not only had the most growth most month over month but solidified being the top choices. This highlights the importance of a Federal Reserve rate hike, as does the second choice to a lesser degree, with the US dollar. European risk premium dropped in importance as a driver of equity prices as did the price of oil. The market correlated commodities did not consider geopolitical risks such as a US election.

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