If history does not repeat itself, it certainly rhymes and fools do like to rush in…courtesy of The Telegraph:
Bank of America’s monthly survey of investors showed a dramatic rise in confidence in August, with a net 72pc expecting growth to accelerate over the next year. It is the highest in reading since 2009.
Almost everybody expects bond yields to rise as deflation fears evaporate, with just 3pc still worried about the risk of an economic relapse. Managers have slashed their bond allocation to a 28-month low.
The survey is watched by veterans as a “contrarian indicator”, tracking herd mentality at key moments. Michael Hartnett, the bank’s investment strategist, advised clients to take the opposite trade and buy US Treasury bonds.
The exuberant mood comes as margin debt on Wall Street hovers near $377bn, just below its all-time high and well above peaks before the dotcom crash and the Lehman crisis.
The bank described this form of debt as “a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. If the stock rises, they end up making far more money. If the stock crashes, the opposite materialises. This kind of speculation is highly alarming.”
The bank warned that forced sales of stocks can set off panic and a rush for exits, snowballing into a crash, as happened in 1929. It said the equity rally may have further legs but it cited “astonishing similarities” between the latest patterns and events preceding prior market crises.
Andrew Lapthorne from Societe Generale said the rush for leverage is a classic sign of a credit cycle near exhaustion. “Profits have been ticking along at stall speed just as in 2006 and 2007, and just like then people are resorting to leverage to squeeze out the last dime,” he said.
Mr Lapthorne said the new twist is that US profits have begun to stall as well, with cash flow growth falling from double-digit rates to zero. He said the rise in margin debt is matched by leveraged excess across the system, with debt-driven buy-backs of corporate shares running at a $400bn annual rate. Leveraged buy-outs are back in vogue. Junk bond yields are near record lows.
“When everybody is jumping up and down and partying, that is the time to worry. Once the market turns nasty we could see a negative feedback loop. Debt is always a killer in the end,” he said.
Investors are betting the US Federal Reserve is about to taper bond purchases for healthy reasons, because the US economy is strong enough to stand on its own feet.
The counter-view is that the Fed is tightening for “unhealthy” reasons, because it has taken to heart warnings from the Bank of International Settlements about the dangers of excess leverage and a fresh asset bubble.
“The Fed is really acting out of anxiety. They are trying to package this in cotton wool, telling us everything is alright, but we don’t think the US economy has reached escape velocity,” said Mr Lapthorne.
Bank of America said there has been a dramatic divergence between “Main Street” and “Wall Street”. While the US economy has grown by $1.3 trillion since 2009, the US stock market has added $12 trillion.
The bank said nominal GDP growth over the past four quarters has been the slowest ever recorded outside a recession. This would not normally be circumstances when the Fed took away the punchbowl and tightened credit.
While the eurozone appears to have stabilised, this falls short of recovery and is too little to stop the debt trajectories of southern Europe rising further. The worry is that investors have already pocketed the gains of a cyclical expansion that does not yet exist. “While tail risk is diminished, it is not dead. Expect the unexpected,” said Bank of America.