The third quarter is officially over, and in the stock market, the Dow (^DJI) posted its worst September performance in two decades – down nearly 2800 points, or 8.9% for the month – while the S&P 500 (^GSPC) and The Nasdaq Composite (^IXIC) is now in the red for three consecutive quarters for the first time since the global financial crisis.
And as investors brace for the historically volatile (and crash-prone) month of October, some on Wall Street are embracing 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” in?
BofA Securities’ global research team, led by Michael Hartnett, has navigated the curves thrown into 2022 far better than most. In their latest letter, Hartnett & Co. reflect on the “broken, freaky post office[Quantitative Easing] financial system installation” and throw down the gauntlet at the crowd that’s on the ground.
“We’re tactical bears,” the BofA says, recommending bets on lower stock prices and higher yields (especially the two-year term) through Halloween.
This image of US dollars flowing through pipes was created by Yahoo Finance using DALL E AI software. (OpenAI)
They cite the recent actions of the Bank of Japan and the Bank of England as evidence that central bankers are adopting ad hoc policies that are doomed to fail. The moves in London were particularly dizzying: British authorities aggressively hiked interest rates to fight inflation (restrictive), then proposed a tax cut to ease working class pain (stimulant), and then – in the face of pension funds that on the brink of collapse — obligation to purchase an unlimited number of bonds for a certain period of time (also stimulating).
In the US, the situation may not be so dire, but cracks are emerging that show financial markets are creaking under the stresses of massive and often ill-timed policy action.
Central banks have tightened financial conditions to the point where the pipes of global financial markets could burst, BofA said, after already draining $3.1 trillion from their balance sheets through quantitative tightening (QT).
The story goes on
BofA:
Investors, meanwhile, are grappling with a generational shift in market regimes that will inevitably take time and patience to navigate. BofA painted a stark picture of the dramatic transition.
The “bullish deflationary era of peace, globalization, fiscal discipline, quantitative easing, zero interest rates, low taxes, [and] Inequality” is slowly giving way to an “inflationary era of war, nationalism, tax panics, QT, high interest rates, high taxes, [and] inclusion,” the analysts wrote.
At the same time, authorities have to react to everyday realities – often without the luxury of waiting. BofA believes global authorities are likely to come together and coordinate policy if the carnage continues leading up to a critical G20 meeting in mid-November.
Until then, BofA sees the S&P 500 continuing to fall towards the numerically symmetric target of 3333. Rounded to the nearest hundred, her advice is: “Nibble 3600, bite 3300, swallow 3000”. The S&P 500 closed at 3585.62 on Friday – a fresh 2022 low – suggesting a light snack of battered large-cap stocks for those keen to stake cash on the sidelines.
Looking ahead to 2023, BofA expects the “big low” in the first quarter as the recession and credit shocks peak. From there, the bank forecasts that the ’23 trade’ will be short the dollar, while EM, small cap and cyclical stocks will be long.
BofA stressed that investors shouldn’t expect to get anywhere near historic 10% annual returns — let alone the 14% returns achieved over the past decade — and simply be aware of the “more limited upside potential of risky assets.” should.
After a remarkably tumultuous year for investors, perhaps 2023 will be a welcome change of pace with “limited upside”.
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