There is just one question one everyone’s mind: with retail sentiment plumbing record lows…
… leading to the first retail monthly outflow since the covid crash…
… and with institutional sentiment also near record lows…
… hampered by near-zero liquidity in the market…
… all traders want to know is whether after the $6.3 trillion wipeout in US stocks since March, “have we finally hit peak capitulation”, and is this the market bottom?
Alas, in responding to the question of “are we there yet“, BofA’s Michael Hartnett has some bad news: No, and explains. “Fear & loathing suggest stocks prone to imminent bear market rally but we do not think ultimate lows have been reached, nor ultimate highs in yields.” he BofA strategist BofA then refers to his “capitulation” checklist (shown below) using today’s data vs COVID ’20, Euro-debt crisis ’12, GFC ’09, tech bubble ’01 data @ lows…
… and finds:
- BofA FMS cash level 5.5% of AUM…capitulation
- BofA FMS growth expectations net -71%…capitulation
- BofA FMS profits expectations net -63%…capitulation
- BofA FMS rate expectations net +86%…no capitulation: cut expectations always seen at lows
- BofA FMS equity AA net +6%…no…lows require -20-30% allocation (i.e. investors UW stocks)
- BofA FMS bond AA net -68%…no…lows require investors to close their UW bond allocation
- BofA GWIM private client equity AA 63%…no…prior lows saw equity allocations pullback to at least 56%
- Equity inflow unwind…no…for every $100 inflows past few weeks we have seen just $4 redemptions vs >$50 prior in prior bear markets
- Equity redemptions % AUM….no…outflows thus far 0.2% AUM vs 3-6% at prior lows.
Hartnett goes on to define the definition of true capitulation which he says happens when love breaks down and “investors sell what they love”. Apple is a poster child for QE bull market; it is now in bear market and looking at key levels, the 100-week moving average for Apple is $137 (big one to hold), 200-week is $97.
In a separate note, Citi global strategist Robert Buckland asks a similar question, “How far could this derating go“, and answers that the MSCI AC World now trades on its long-term median 12m fwd PE of 15x, well down from last year’s 20x peak.
But Buckland warns that the global equity market does not yet look especially cheap against history. For example, a drop to the 10x multiple seen during the 2011-12 Eurozone crisis would imply another ~33% derating.
So what is driving valuations lower and when might it stop? According to the Citi strategist, one way to answer this all-important question is to revisit the close relationship between real yields and equity valuation.
Monetary easing in 2019-2020 helped to drive down real yields and rerate equities. Monetary tightening in 2022 is driving up real yields and derating equities. The current PE of the MSCI AC World (15x) is close to that implied by the historic relationship with 10Y US TIPS yields (currently +0.3%).
That said, some equities are more rate sensitive than others. Figure 5 splits the MSCI AC World benchmark into its Growth and Value indices. The Growth index tracks moves in real yields especially closely. 90% of its PE can be explained by the level of US 10y TIPS yields (Figure 6). The Value index is less sensitive (R-squared 46%). In 2019-20, lower real yields led to higher equity valuations, but that rerating was driven much more by Growth stocks than Value stocks.
Buckland’s bottom line: “now that central banks are unwinding monetary support, Growth stock valuations have further to fall.”
More in the full notes available to professional subscribers.