Earlier this week, as Trump’s tax reform was finally being voted through Congress, we showed that in a surprising market reaction, total asset returns – those combination of S&P and 30Y Treasurys – saw their biggest two-day drop since last December, a shock which led to one of the biggest declines for risk-parity investors in months.
As of this morning we now know the reason for this steep stumble: as BofA Chief Investment Officer Michael Hartnett writes in his latest, and last for 2017, Flow Show report US tax reform passage was greeted by near-record redemptions across key asset classes, with $14.5 billion withdrawn from equities – the largest redemption since Brexit – and a further $3.2bn from bonds, the largest in 52 weeks, and even a modest $0.4bn was pulled from gold funds.
For Hartnett, the explanation is as simple as “Once Bitten, Twice Shy” and notes that “thus far, in stark contrast to post-election flows of Nov’16-Mar’17 (Chart 1), the prospect of fiscal stimulus not translating into “Trump trade” inflows, e.g. US Financials, Small Caps, Value funds see biggest week of redemptions ($14.6bn) since US election.”
However, far from a contrarian indication, to BofA this “supports ongoing risk-on trade in Jan’2018” as more are again forced into risk assets.
Meanwhile, when looking at the one asset class many believe is a predictor of a bear market, Hartnett points out big bond redemptions driven by HY outflows ($5.3bn); In fact, this week was the 8th consecutive week of HY outflows and marks longest streak since Global Financial Crisis of 2008, which as BofA warns is “historically a harbinger of weaker HY returns (Chart 2).”
And meanwhile, just to confuse everyone, despite the gloom telegraphed by junk bonds US surveys remain consistent with 5-6% real GDP growth in Q1/Q2 (Chart 3) and accelerating bond outflows.
Indicators – whether bullish or bearish – aside, BofA has a simple playbook for how to trade assets in the first quarter, and it is based on the following “Treasury Roadmap” which is based on the direction and magnitude of 10-year Treasury yield moves in Q1 of 2018 to determine optimal portfolio, as follows:
- <2% = deflation plays,
- 2-2.5% = QE-winners,
- 2.5% = risk-on trades,
- >3% = inflation plays