Global markets could be at risk of a CRASH scenario that threatens to create a turbulent autumn and place pressure on the rotation out of bonds into equities, according to Bank of America Merrill Lynch analysts.
A note by chief investment strategist Michael Hartnett and his team highlights several CRASH factors – or conflict, rates, Asia, speculation and housing – that could lead to a “contagious autumn market event”.
It says: “Prior to the chemical attack in Syria on 21 August, equities were up 10 per cent year- to-date, commodities were down 2 per cent and bonds were down 5 per cent. The ‘risk-on’ nature of 2013 was amply highlighted by the outperformance of Greek government bonds versus US Treasuries.
“But the ‘great rotation’ consensus is now under pressure. A ‘buyers strike’ is suddenly visible in late August as investors see the potential for event risk in coming weeks. While we are still big believers of the great rotation we feel it is prudent for investors to understand the potential risks to markets over the next quarter.”
The note explains conflict risk could come in the form of military intervention in Syria, which could create a spike in oil prices, or policy conflict as emerging markets attempt to stem capital outflows and currency losses.
Rate risk could be created by a “bungling” of the Federal Reserve’s tapering plans,whereby it is interpreted as fine-tuning rather than genuine confidence that stimulus is needed to the same extent. In addition, the note says a sell-off in rates would remove a key driver of the bull market.
Looking to Asia, BofA ML highlights the continued decline of the Indian rupee and the country’s current account crisis, as well as the risk that weakness in the region could add downward pressure on the Chinese economy.
The analyst adds speculation risk could be indicated by the sharp pick-up in “indicators of leverage” such as non-coupon notes, covenant-lite loans, leveraged buyouts, dividend recapitalisations and 2nd lien loans. This speculative activity was also high before 2008’s financial crisis.
Finally, BofA ML points out the “rapid rise” in market rates in the US has slowed activity in the country’s housing market. The housing market has been a cornerstone of the US recovery, so any impediment there could threaten investor sentiment.