2022 reveals “freaky post-QE financial system plumbing,” says BofA
The third quarter is officially over, and the stock market saw the Dow (^DJI) post its worst September performance in two decades — down nearly 2,800 points, or 8.9% for the month — while the S&P 500 (^GSPC) and Nasdaq Composite (^IXIC) is now in the red for three straight quarters for the first time since the global financial crisis.
And as investors prepare for the historically volatile (and crash-prone) month of October, some on Wall Street are rallying around the idea that stocks are on the cusp of a meaningful rally. Two key questions remain: How far can stocks go? And is “The low” included?
The global research team at BofA Securities, led by Michael Hartnett, has navigated the curveballs thrown by 2022 far better than most. In their latest message, Hartnett & Co. reflects. over the “broken, freaky post-[Quantitative Easing] the economic system plumbing”[ads1]; and throw down the gauntlet on the bottom-is-in-the-crowd.
“We are tactical bears,” says BofA, recommending bets on lower stock prices and higher yields (especially in the two-year period) for Halloween.
They cite recent actions by the Bank of Japan and the Bank of England as evidence that central bankers are adopting ad hoc policy responses that are doomed to failure. The moves in London were particularly dizzying: British authorities aggressively raised interest rates to fight inflation (restrictive), then proposed cutting taxes to ease the pain for the working class (stimulative), and then — faced with pension funds teetering on the brink of collapse — committed themselves to buy an unlimited number of bonds for a period (also stimulating).
The situation may not be as dire in the US, but cracks are emerging that reveal financial markets are creaking under the strains of massive and often incongruous political responses.
Central banks have tightened financial conditions to the point where the plumbing of global financial markets could burst, BofA said, after draining $3.1 trillion from their balance sheets through quantitative easing (QT).
Investors, meanwhile, are struggling with a generational change in the market regime, which necessarily takes time and patience to navigate. BofA painted a strong picture of the dramatic transition.
The “bullish deflation era of peace, globalization, fiscal discipline, QE, zero rates, low taxes, [and] inequality” is slowly giving way to an “inflationary era of war, nationalism, fiscal panic, QT, high prices, high taxes, [and] inclusion,” the analysts wrote.
At the same time, the authorities must react to daily realities – often without the luxury of waiting. BofA believes global authorities are likely to come together and coordinate policy if the carnage continues into a critical G20 meeting in mid-November.
Until then, BofA sees the S&P 500 plunging further to the numerically symmetric target of 3333. Rounded to the nearest hundred, their advice is to “nip 3600, bite 3300, rave 3000.” The S&P 500 closed at 3,585.62 on Friday — a fresh 2022 low — suggesting an easy snack of battered large-cap stocks for those scrambling to cash in on the sidelines.
Looking ahead to 2023, BofA expects the “Big Low” in the first quarter as recession and credit shocks peak. From there, the bank estimates the “trade of ’23” will be short the dollar while long emerging markets, small caps and cyclical stocks.
BofA stressed that investors should not expect to achieve anything close to the historic 10% annualized return — much less the 14% return achieved over the past decade — and simply be aware of “more limited upside from risk assets.”
After what looks set to be a remarkably turbulent year for investors, perhaps “limited upside” will be a welcome change in 2023.
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