- Financial markets are providing clear clues about where we are in the cycle, according to Michael Hartnett, the chief investment strategist at Bank of America Merrill Lynch.
- For example, commodities are having a strong year and are the best performers so far while yields are rising and total returns are getting crushed.
- His trading advise, detailed below, is truncated in the acronyms Long ABCD, short EFH.
Almost nine years since the Great Recession, the US economy is in its second-longest expansion and is generating curiosity about when and how it will sour again.
Michael Hartnett, Bank of America’s chief investment strategist, identified some clues based on how various financial markets have traded this year.
His rundown of how markets have performed this year include the fact that commodities, the best performing asset class, are up 12%. Strategists at Goldman Sachs and elsewhere have recommended buying commodities because they would benefit in a macro environment where inflation is rising and developed economies are approaching or past the peak of their growth rates.
Also, bonds are having a rough year as investors expect that inflation will increase and shortchange the future value of their investment. The annualized total return on the 10-year Treasury note is -10% this year, the worst since the 12.6% decline in 1931.
Similarly, bonds issued by the highest-rated companies are getting crushed; AAA-rated investment grade bonds are down 11%, the worst decline on record.
Stocks are having a much more volatile year compared to 2017, and have gained just 2% so far.
“2018 returns scream Fed tightening & late-cycle,” Hartnett said in his note on Thursday.
Just as important as how markets are trading is that the Federal Reserve and other central banks around the world are reversing years of the accommodative monetary policy. In fact, minutes of the Fed’s most recent meeting released on Wednesday showed it was considering tweaking its statements’ language that said monetary policy remained “accommodative.”
Hartnett published recommendations on how investors can position themselves for the latter phase of the cycle, although he’s not telling clients to throw in the towel just yet. His advice is to stay defensive until an unforeseen event or a rise in the unemployment rate forces the Fed to stop raising interest rates.
He truncated the trading advise into simple acronyms: Long ABCD, short EFH.
- Long AAA-rated assets
- Long T-Bills
- Long China stocks & Crude oil
- Long US Dollar
- Short EM local currency-denominated debt
- Short FAANG
- Short High Yield bonds