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Contrarian Themes Are Outperforming Consensus Themes

Major U.S. stock indices are in the red again on Monday as investors remain unable to make up their minds. Investors poured cash into bonds, equities, government bonds and gold last week but unloaded financial stocks, investment-grade bonds and tech stocks.

Bank of America Merrill Lynch analysts say they’re seeing this year’s contrarian themes beat consensus themes, which means investors are shunning quality, liquidity and volatility in favor of junk, leverage and beta.

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Investors go risk-on

BofAML Chief Investment Strategist Michael Hartnett and team said after their firm's Bull & Bear Indicator hit "extreme bear" territory, investors were quick to buy.

BofAML investors poured $7.2 billion into bonds, $6.2 billion into equities and $1.1 billion into gold, which marked the fifth week of inflows to precious metals. Last week's inflows to equities were the highest in 11 weeks. International equity funds racked up $3.8 billion in inflows, while inflows to government bonds were at $3.6 billion last week. Emerging market bonds and EM stocks each saw inflows of $2.4 billion, while investors bought $1.5 billion in high-yield bonds. Bonds saw their biggest inflows in 39 weeks at $7.2 billion.

On the other hand, investors sold $1.5 billion in financial stocks, $1.4 billion in investment-grade bonds, and $600 million in tech stocks.

The BofAML team described investor feedback on their buy signal as initially bringing skepticism about the size and duration of rally and then a general obsession about whether not the markets have reached the so-called "Big Low." They also said that this obsession quickly transformed into a chase for EM and U.S. stocks. Additionally, they said "few" are still bullish on tech or financials.

In order for "the Big Low" to occur, Hartnett and team said inflows to credit funds are needed because this will signal that the Fed has finally ended the cycle of higher credit spreads and weaker growth. Outflows from investment-grade, high-yield and EM debt have climbed to $62 billion over the last eight weeks, so they are watching this metric to try to determine where this so-called "Big Low" is.

Contrarian Themes Consensus Themes


The BofAML Bull & Bear Indicator triggered a buy signal for risk assets the week of Jan. 3, but the following week, the indicator is back up to 2.2, which keeps it in the bearish end of the spectrum but moves it out of buy territory. Hartnett and team said the last time there was a "brief" buy signal in this way was in February 2003, and just three months after, global equities had climbed 9%.

They still believe the global earnings per share forecast for 2019 is too high as consensus sits at 7.3%, while BofAML pegs earnings growth at flat to up 5%. However, they also said capitulation is underway in this area as well. The Global Earnings Revision Ratio plunged to 0.48 last month.

The Federal Reserve also capitulated recently, and estimates put the December 2020 Fed funds rate down to 2.25% from 3% over the last three months. According to the BofAML team, the "moment of Maximum Quantitative Tightening" will be toward the end of March.

Contrarian Themes Consensus Themes

Contrarian beats consensus

The BofAML team said last week's leaders include stocks in China and Germany, small-cap stocks in the U.S., semiconductors, energy stocks, U.S. and Euro high-yield bonds and emerging market currencies. Last week's laggards included Treasuries, the yen, and healthcare and utility stocks. They summed up their findings thus: "basically 2019 contrarian themes of 'junk,' 'leverage' & 'beta' outperforming 2019 consensus themes of 'quality,' 'liquidity' & 'volatility.'"

Hartnett and team also said the moves the market has been seeing recently have been extreme because the windows of opportunity in risk assets tend to shrink in late-cycle periods.

This article first appeared on ValueWalk Premium