BoAML Survey: Financial Markets Overvalued and Bond Shock Possible; Wage Gains?

by the Curmudgeon

Introduction:

For a very long time, Victor and I have claimed that bonds and stocks are stupendously overvalued.  This week, the Bank of America Merrill Lynch (BoAML) Fund Manager Survey (FMS) agreed with our assessment.  All quotes and excerpts from that survey referenced in this article are from the BofA Merrill Lynch Global Research report, except two charts courtesy of the Financial Times.

 

A different BoAML study (subscription only) found that the small US wage growth has been due in large part to more states adopting a higher minimum wages.  Hence, US worker pay increases have occurred most frequently in the lowest-paying jobs, including fast-food outlets such as McDonald’s and large retailers such as Walmart.

 

Both of those surveys are described in this article along with related comments and analysis.

 

Overvalued Stocks & Bonds Cause Move to Cash:

 

Global bond and stock market valuations have reached their highest level since the early 2000s, leading investors to adopt a bearish outlook amid potential frothiness in the world’s risk assets, according to the BoAML FMS released this past week (subscription required).

 

 
Chart courtesy of the Financial Times

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Propelled by record amounts of monetary stimulus, ZIRP and even negative interest rates from several global central banks, 54% of fund managers surveyed by Bank of America Merrill Lynch said a combined measure of bonds and equities is now at an all-time record overvaluation for the survey, which started in 2000.  Mark Hulbert recently wrote something similar in an August 16th MarketWatch column:

The U.S. stock market currently is more overvalued than it was at almost every bull market peak over the past 100 years.  That’s crucial, since it undercuts one of the arguments some exuberant investors currently are using to try to wriggle out from underneath the otherwise bearish message of various valuation indicators.

 

Fears of overvaluation drove money managers to cash at the start of the month, with investors increasing their cash holdings to 5.5% in September, up from 5.4% in August.  20% of respondents said they would rather hold cash than “low-yielding” equivalents such as government bonds/notes, whose prices have been driven to record highs in recent months.  More than 40% of money market managers said they were prompted to shift into cash by a gloomier market outlook amid a worldwide hunt for higher-yielding assets.  That’s reflected in this chart:


Chart courtesy of the Financial Times

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The chart below shows the trend in Fund Manager cash levels since 2001. Note the uptrend since 2013:

Chart Courtesy of BoAML

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BoAML - Negative Bond Shock Possible: 

 

“Investors see an unambiguous vulnerability to ‘bond shock’ among risk assets, with the most crowded negative interest trades and EM equities susceptible should the Fed and especially the BoJ fail to reduce bond volatility in September,” said Michael Hartnett, chief investment strategist of BoAML.

 

Manish Kabra, European equity quantitative strategist, added that, “European investors have increased cash allocations to cover their sector underweights in Banks and Commodity sectors. Macro optimism is firmly at pre-Brexit levels, with economic growth expectations at their strongest since June.”

 

Here’s an edited excerpt from the BoAML FMS: Unambiguous vulnerability to bond shock:

 

·       83% believe BoJ & ECB will maintain negative rates next 12 months.

·       82% admit bond prices in developed markets are "frothy."

·       US Treasuries seen as biggest driver of stock prices next 6 months.

·       FMS hedge fund exposure to stocks jumped to the highest since May 203 "taper tantrum,” which underscores the market’s vulnerability to a bond shock.

·       Combined valuation of bonds and stocks at or very close to an all-time high (overvaluation of stocks highest since May 2000).

·       Most vulnerable longs are all "Negative Interest Rate Policy (NIRP) winners."

·       Most crowded trades are all "NIRP-winners": long High Quality stocks; long US/EU Corporate bonds; long Emerging Market debt.

·       September FMS shows first meaningful reduction in bond proxy exposure (staples, utilities, telcos), as well as reduction in "high growth" US stock market.

·       Both REITs & tech stocks remain big, stubborn longs.

·       Emerging Market equity overweight at its highest level in 3.5 years.

·       All of the above are vulnerable should the Fed and especially BoJ fail to reduce bond volatility in September.

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To underscore the overvaluation and risk in bonds we quote from the latest BoAML CIO Report:

 

The quest for yield, driven by low global rates and insatiable investor demand, has forced the classic (fixed income) risk/reward ratio to record levels. By some measurements, risk levels are at or near historic highs, while on the reward side interest rates and income from fixed income securities have been steadily moving lower for 35 years. We believe this is not the time to take excessive risk in order to capture additional yield. However, opportunities do exist and strategies can be constructed to maximize returns in this low-return environment. We suggest that investors proceed with caution.

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US Worker Wage Gains Coming From Those Who Earn the Least:

 

Real average hourly earnings for all employees decreased 0.1% from July to August, seasonally

adjusted, the U.S. Bureau of Labor Statistics reported on Friday, Sept 16th.    Real average weekly earnings decreased 0.4% over the month due to the decrease in real average hourly earnings combined with a 0.3% decrease in the average work week. 

 

However, it’s not been widely reported that US worker wage gains are not being spread evenly amongst all employees.   It’s well known that executive pay has gone off the charts, but what about wage gains for other workers?  From a Sept 13th Washington Post article: 

 

“Since 2014, increases in wages have accelerated for the one in five workers earning the least, according to new research by Bank of America. In this group, wages are now increasing at roughly 4% year over year.”

 

The BoAML report suggests that the little wage growth there has been in the US is due to increased minimum wages and has thus benefited the “working poor” rather than the middle class.  That’s hardly the sign of a resilient, growing economy!

 

“The pace is sub-par and closer inspection shows a two-tier market in which low-pay sectors are seeing the strongest wage gains, with slower trends elsewhere,” BoAML states. “Upward wage pressure is due to state-level minimum wage increases and a shortage of young/less-educated workers; factors unlikely to trigger a breakout in wages more broadly.”

 

A July 6th USA Today article titled: Low-paid workers are leading in wage gains corroborated the above point.

 

An unusual flurry of minimum wage increases took effect Friday in Maryland and Oregon, as well as in 13 cities and counties, including Los Angeles, San Francisco, Chicago, Washington DC and Louisville, Ky., according to the conservative Employment Policies Institute and liberal National Employment Law Project. The initiatives will boost minimum pay to as much as $13 to $14.82 an hour in parts of California.  And the latest studies underscore that their efforts have been stunningly fruitful, with the pay of low-wage workers rising far more rapidly than their higher-earning counterparts.

 

By driving down % returns on workers’ savings and squeezing their fixed income pension fund investments, “unconventional monetary policies (QE, ZIRP, NIRP, etc.) raise the risk that standards of living will drop after today’s workers become tomorrow’s pensioners,” wrote Henny Sender in this Saturday’s Financial Times (on line subscription required).

 

ShadowStats’ John Williams says: “Consumer income and liquidity remain seriously distressed.”

 

- Consumer Conditions Continue to Deteriorate

- 2015 Household-Income Boost Reflected New Surveying of IRA Withdrawals and Census-Gimmicked Interest Income

- Consistently Surveyed, 2015 Household Income Remained Shy of Its Level at the 2009 Trough of the Economic Collapse and Held Below Levels of the Late-1980s and-Early 1970s

- Real Consumer Credit (Ex-Student Loans) and Household-Sector Debt Outstanding Are Down Respectively by 13.7% (-13.7%) and 12.6% (-12.6%) from Pre-Recession Peaks

- August 2016 Annual Inflation Firmed by 0.2% to 0.3%, with CPI-U at 1.1%, CPI-W at 0.7% and ShadowStats at 8.7%

- August Real Retail Sales Plunged by 0.5% (-0.5%) Month-to-Month, with Annual Growth at a 30-Month Low, an Intensifying Recession Signal

- August Real Earnings Fell by 0.3% (-0.3%)

- Markets Increasingly Seem to Anticipate a Rate Hike

 

We’ll end on that note.

Good luck and till next time...

The Curmudgeon
ajwdct@sbumail.com

 

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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