November was characterised by a continued push into riskier assets, including cyclicals like financials and energy and a collective withdrawal from more defensive positions, such as bonds and gold, a research report from the bank revealed.
Bonds’ losses, totalling $34bn over six consecutive weeks, and gold’s $7bn loss over four weeks, mark the most intense redemptions either asset class has seen since 2013’s Taper Tantrum.
There was even an ‘exodus’ from the big yield winners of 2016 — Investment Grade, REITs and emerging market debt. While IG outflows were comparably smaller, $46m over five weeks, REITs and EM debt lost $0.4bn and $2.4bn, respectively, in the same time frame.
Much to BAML’s surprise, equities on the whole suffered $0.6bn in outflows during the period, despite the eleventh consecutive week of inflows for financials and energy’s largest inflow in twelve months ($1.4bn). Redemptions on the EM and European equities side, totalling $1.8bn and $1bn, respectively, ultimately dragged the performance of the asset class down.
The BAML report also highlighted bank loans as one of November’s winners, as it generated $1.7bn, its largest inflow in three years. An increase in bank lending activity would likely force a Fed rate hike, the bank suggested.
Though it is tempting to read this data as a story of the cyclical comeback, especially with cyclicals at a 10-year high to defensives, BAML cautions that the so called ‘great rotation’ has much further to go. On a cumulative basis over the past ten years, $1.5tn has been amassed into bonds versus zero into equity funds. Similarly, a rotation in the opposite direction would not be an overnight phenomenon.
Instead, the bank suspects that what began as a ‘violent rotation’ is “now morphing into broader risk rally as cash and bond exposure drops in favour of stocks.”
And by February/March of next year BAML anticipates pressure from the Fed to play catch up with the accelerated bank lending activity will lead to a ‘bear flattening’ of the yield curve. BAML added that higher growth and higher rates would provide the catalyst for volatility and rising risk of Wall Street busts à la ’87, ’94, ’98, ‘08.
In this scenario, cash and defensive assets will be preferable to the value stocks and cyclicals currently trending.
As a result, the bank said it would tactically remain long Japan, European and UK stocks, real estate, commodities and the US dollar until the ‘bear flattening begins.’