Analysts at the Wall Street behemoths cite signs including the breakdown of longstanding relationships between stocks, bonds and commodities in addition to investors ignoring valuation principles and data. All of it means credit and stock markets are at risk of a painful drop.
“Equities have become less correlated with FX, FX has become less correlated with prices, and everything has become less sensitive to oil,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote in a note published Tuesday.
His bank’s version shows assets throughout the world will be the least correlated in almost a decade, even after U.S. stocks joined high-yield credit in a selloff triggered this month by President Donald Trump’s political standoff with North Korea and racial violence in Virginia.
Just like they did in the investors are pricing assets based on the risks specific to an individual safety and industry, and shrugging off broader drivers, like the latest release of manufacturing data, the model shows. As traders look to remain bullish, traditional relationships within and between asset classes tend to break down.
“These low macro and micro correlations confirm the concept that people’re in a late-cycle environment, and it’s no accident that the last time we saw readings this low was 2005-07,” Sheets wrote. He advocates boosting allocations to U.S. stocks while reducing holdings of corporate debt, where consumer intake and energy is more heavily represented.
That dynamic is also helping to keep volatility in currencies, bonds and stocks feeding risk appetite according to Morgan Stanley. Regardless of the turbulent past two weeks, the CBOE Volatility Index remains to post a year of declines.
For Savita Subramanian, Bank of America Merrill Lynch’s head of U.S. equity and qualitative strategy, signals that investors aren’t paying much attention to earnings is another indication that the global rally may soon run out of steam. Companies that outperformed analysts & #x 2019; sales and profit quotes across 11 sectors saw no benefit from investors, according to her research.
“This absence of a reaction could be another late-cycle signal, indicating positioning and expectations more than reflect excellent results/guidance,” Subramanian wrote in a note.
Oxford Economics Ltd. macro strategist Gaurav Saroliya points to another red flag for U.S. equity bulls. Non-financial companies after inflation’s gross value-added — a measure of the value of merchandise after adjusting for the costs of production — is negative on a basis.
“The cycle of actual profits has turned enough to be a possible source of concern in the four quarters,”. “That, together with the most expensive equity valuations among major markets, should stress investors in U.S. stocks. ”
The thinking goes that a classic late-cycle growth — an economy with full employment and slowing momentum — tends to see a decrease in corporate profit margins. The U.S. is in the mature stage of the cycle — 80 percent of conclusion since the previous trough — based on margin patterns going back to the 1950s, according to Societe Generale SA.
After finishing credit markets are overheated, HSBC’s global head of fixed-income research, Steven Major, told clients to cut holdings of European corporate bonds earlier this month. Premiums don’t compensate investors for the prospect of liquidity risks, capital losses as well as an increase according to Major.
Citigroup analysts say markets are on the cusp of entering a summit in front of a recession that pushes on bonds and stocks into a bear market.
Spreads may widen in the coming months thanks and as investors fret over company leverage that is elevated, they compose. But, stocks are anticipated to rally further partly due to buybacks, the strategists conclude.
“Bubbles are common in these equity Citigroup analysts led by Robert Buckland said in a note Friday.
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