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With everyone leaning one way, markets have a way of delivering the unexpected.
Known as pain trades, these shifts that leave a large swathe of investors flatfooted were the focus of BofA Securities’ most recent Flow Show note.
Strategist Michael Hartnett lays out the current scenario.
On one hand, no one expects a recession and everyone is expecting two to three Fed rate cuts over the next six to 12 months. And with no-landing risks peaking in the first half, risk assets have responded well as the tail risks of a Fed hike, Treasury yields above 5% and a collapse in the yen (FXY) have been removed.
On the other hand, visibility of U.S. labor weakness growing at a time of a super-low U.S. savings rate and the end of excess savings. Jobless claims are up as small-business credit conditions weaken and growth in white collar payrolls has been flat for the past three months while the unemployment rate is rising, none of which is consistent with collapsing credit spreads. In addition, the BofA Global EPS Model is rolling over and the catalysts for a Goldilocks scenario like U.S. employment, the U.S. consumer and global PMIs are “looking ropey.”
Best pain trade for bears: Hedging a rise in the probability of a hard landing by going long the 30-year Treasury (US30) and Consumer Staples (XLP), both of which are “unloved.”
Best pain trade for bulls: Front-run a Fed that is itching to cut rates, betting on the “nascent rally in shunned ‘leverage’ plays like China (FXI) (MCHI), the U.K (EWU), Utilities (XLU) and regional banks (KRE) extends to “duration,” like biotech (XBI) (BBH) and solar (TAN).
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