BOA: The Three Trades We Like Best For An S&P 500 Rally

S&P 500 Rally

Last week, Bank of America published a research report detailing the three trades its chief investment strategist, Michael Hartnett and team like in the current environment. The report  details the three investment calls which are illustrated by 12 charts. Two of the three calls are based on existing investment strategies already detailed in BoA notes, including the “Icarus Trade” and “Davos Man portfolio to Joe Six-Pack portfolio.”

The three calls essentially blend into one. Overall, they are a bullish call on equities. Year-to-date market price action is pro-risk and pro-cyclical. Global equity is up 4.8% year-to-date, bonds are up 0.2% year-to-date, and the dollar is down 0.9% year-to-date.

BOA: The Three Trades We Like Best For An S&P 500 Rally

Hartnett and team expect this trend to continue. They believe their so-called Icarus Trade (a 10% melt-up this quarter before a meltdown later in 2017) is still on the table as the bank’s key Bull/Bear ratio stands at only 6.3, two points off the “Greed” level of eight. A market top Hartnett believes will most likely coincide with “peak macro” data. US ISM index (this remains single best indicator of profit cycle) above 58 would be the first sign that investors should “fade the euphoria” as best of global EPS growth revisions would likely have already occurred.

To ride the rest of the Icarus Trade, BoA’s equity team continues to like the “Davos Man portfolio to Joe Six-Pack portfolio” strategy detailed earlier in the year. The strategy is essentially a move away from a more defensively positioned portfolio towards an active cyclical recovery bias. While the Davos Man portfolio was positioned for austerity, globalization, large cap stocks, outperforming technology and passive investing, the Joe Six-Pack portfolio will try to take advantage of a resurgence in value stocks, cyclical stocks, small-cap banks and real assets. Here’s how Hartnett initially viewed this rotation when he first wrote about in January:

“The conventional wisdom has flipped from “Davos Man” portfolios to “Joe Six-Pack” portfolios in recent quarters. But let’s not forget the extremity of the starting point of this Great Rotation: global interest rates were at 5,000-year lows in Jul’ 16 and this induced acute dislocations in asset/sector/regional valuations

• $1.5 trillion inflows to bond funds in past 10 years vs $0 to equity funds
• Real assets at 90-year lows versus financial assets
• US stocks at 60-year highs versus European stocks, and so on.

Thus we should expect the ongoing rotation out of entrenched Wall Street to Main Street (Table 1) assets to be violent, extreme, and ultimately overshoot.”

One month on and Hartnett is still worried about a sudden correction but is more concerned about investors’ decision to fade inflation before the trade has fully played out:

“We are long “inflation assets”. Investors faded the QE theme too early, the fiscal stimulus theme too early, and should resist temptation to fade inflation; after all…just 7 months ago global rates were at 5,000 year lows…there is still $9.5tn of negatively yielding debt in the world…the valuation of deflation assets remains amazingly high versus inflation assets (e.g. combined market cap of deflationary Google & Apple greater than combined market cap of inflationary EZ/Japan financials)…real assets relative to financial assets are the lowest since 1926… fiscal policy will be eased and a chunk of that easing will be done via infrastructure spending: G6 government spending on public infrastructure is currently lowest since 1948. We project combined fiscal stimulus in US/Canada/Japan/UK/Europe/ China could be close to $1 trillion in 2017.”

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Source: valuewalk