Bank of America Merrill Lynch’s (NYSE: BAC) chief investment strategist, Michael Hartnett, said in a note to clients this week that the “Great Bull” market that came after the financial crisis is now dead as economic growth slows, interest rates rise, and debt crushes.
“The Great Bull Dead: end of excess liquidity = end of excess returns,” Hartnett wrote in the note which discussed markets 10 years after the collapse of Lehman Brothers, the spark that lit the fuse of the crisis.
The liquidity Hartnett is talking about is the liquidity provided by central banks to the tune of $12 trillion through the various easing programs worldwide. Easing that has seen 713 cuts in interest rates according to BoAML.
Leading the way through this has been the U.S. Federal Reserve, which kept its benchmark rate around zero for seven years and inflated its own balance sheet to more than $4.5 trillion at one point.
And all that stimulus led to the S&P 500 rising 335% since the market lows in 2009.
Hartnett believes that in the next phase of the market, investors will will see lower returns, the bulk of which will be had in assets that suffered during this long recovery. But not before we see some significant changes.
“The Fed is now in the midst of a tightening cycle, ignoring structural deflation, focusing on cyclical inflation,” he said. “Until this Fed hiking cycle ends we suspect absolute returns from financial assets will remain slim & volatile.”
The aggressive easing and historically low interest rates fueled a massive increase in global debt, from $172 trillion before the crisis to $247 trillion today. Total U.S. debt has climbed almost 82% since the collapse of Lehman Brothers in September 2008, Chinese debt has risen 460% to $40 trillion in that time, and global government debt is up 73% to $67 trillion.
The BoAML strategist cautions that investors accustomed to the easy money environment we saw after the crisis are underestimating the Fed’s intent to normalize. Since December 2015, the Fed has raised rates seven times and is expected to deliver two more rate hikes before the end of this year.
Hartnett isn’t alone in sounding the alarm. Just last week, billionaire Ray Dalio said “We’re in, I would say, the seventh inning of the cycle… Maybe we have two more years.” Also last week Morgan Stanley strategist Mike Wilson said, “We believe we are in a ‘rolling bear market,’ a market where risk assets across sectors and geographies reprice to account for the removal of central bank provided liquidity.”
Like Harnett, Wilson believes the end of central banks’ easing programs will come with higher volatility as assets and markets lose their ability to absorb shocks, while Hartnett has also cautioned that additional interest rate hikes would cause short-term government bond yields to exceed longer-term rates, otherwise known as an inverted yield curve – a condition that has preceded each of the last seven recessions.
“Yet the Fed is now saying ‘this time is different’ and a flat/inverted curve won’t stop them hiking,” Hartnett wrote. “A much more hawkish-than-expected Fed is the most likely catalyst for fresh losses across asset markets.”
In this environment, Hartnett advises investors look for “inequality, innovation and immortality,” or pharmaceuticals, tech disruptors, and inflation plays like commodities, value stocks, and markets outside of the U.S. and Canada.