December 9, 2023


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2022 is exposing ‘freaky post-QE financial system plumbing,’ BofA says

2022 is exposing ‘freaky post-QE financial system plumbing,’ BofA says

The third quarter is a officially a wrap, and the stock market saw the Dow (^DJI) post its worst September performance in two decades — down nearly 2800 points, or 8.9% for the month — while the S&P 500 (^GSPC) and Nasdaq Composite (^IXIC) are now in the red 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 coalescing around the idea that equities are on the cusp of a meaningful rally. Two key questions remain: How far can stocks rally? And, is “The low” in?

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 missive, Hartnett & Co. reflect on the “broken, freaky post-[Quantitative Easing] financial system plumbing” and throw down the gauntlet at the bottom-is-in crowd.

“We are tactical bears,” says BofA, recommending bets on lower stock prices and higher yields (particularly in the two-year tenor) into Halloween.

This image of U.S. dollars flowing through pipes was created by Yahoo Finance with DALL·E AI software. (OpenAI)

This image of U.S. dollars flowing through pipes was created by Yahoo Finance with DALL·E AI software. (OpenAI)

They cite the recent actions by the Bank of Japan and Bank of England as evidence that central bankers are enacting ad hoc policy responses doomed to fail. Moves in London were particularly dizzying: British authorities aggressively hiked rates to combat inflation (restrictive), then proposed cutting taxes to mitigate the pain on the working class (stimulative), and then — in the face of pension funds teetering on the brink of collapse — committed to buy an unlimited amount of bonds for a period (also stimulative).

The situation may not be as dire in the U.S., but cracks are surfacing that reveal financial markets are creaking under the strains of massive and often incongruous policy responses.

Central banks have tightened financial conditions to the point where the plumbing of the global financial markets could burst, BofA stated, having already drained $3.1 trillion from their balance sheets through quantitative tightening (QT).



Investors, meanwhile, are grappling with a generational shakeup in market regime, which necessarily takes time and patience to navigate. BofA painted a stark picture of the dramatic transition.

The “bullish deflationary 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 rates, high taxes, [and] inclusion,” the analysts wrote.

At the same time, authorities must respond to day-to-day realities — oftentimes without the luxury of waiting. BofA believes that 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-symmetrical target of 3333. Rounding to the nearest hundred, their advice is to “nibble 3600, bite 3300, gorge 3000.” The S&P 500 closed at 3585.62 Friday — a fresh 2022 low — suggesting a light snack of bruised large-cap stocks for those champing at the bit to deploy cash on the sidelines.

Looking forward to 2023, BofA expects the “Big Low” in the first quarter as recession and credit shocks peak. From there, the bank is forecasting the “trade of ’23” to be short the dollar while being long emerging markets, small caps, and cyclical stocks.

BofA stressed that investors shouldn’t expect to achieve anything near the historic annual returns of 10% — much less the 14% returns achieved over the trailing decade — and simply be aware of “more limited upside from risk assets.”

After what is shaping up to be a remarkably turbulent year for investors, perhaps “limited upside” will be a welcome change in 2023.

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