In a research note sent to clients Monday morning, the BAML strategists led by Michael Hartnett issued the following warning:
“Investors remain trapped in ‘The Twilight Zone’, the transition period between the end of QE and the first rate hike by the Fed, the start of policy normalization…until (a) the US economy is unambiguously robust enough to allow the Fed to hike and (b) the Fed’s exit from zero rates is seen not to cause either a market or macro shock (as it infamously did in 1936-7), the investment backdrop will likely continue to be cursed by mediocre returns, volatile trading rotation, correlation breakdowns and flash crashes.”
A “flash crash” occurs when the stock market experiences a rapid, sharp, and volatile drop in prices in a very short period of time. The last major flash crash in U.S. markets took place on May 6, 2010 when the S&P 500, NASDAQ 100, and Russell 2000 all tanked and then partially recovered within one trading day. The Dow fell 998.5 points, or about 9%, within just minutes.
Deutsche Bank’s chief equity strategist David Bianco also showed concern about the markets, telling CNBC’s Squawk Box “I think this is going to be a dangerous summer.”
In a Bloomberg article on Nobel Prize-winning economist James Tobin’s Q ratio measure, authors Lu Wang and Jennifer Kaplan write:
“If you sold every share of every company in the U.S. and used the money to buy up all the factories, machines and inventory, you’d have some cash left over. That, in a nutshell, is the math behind a bear case on equities that says prices have outrun reality.”
So what do the BAML strategists recommend their clients do?
“For this reason we continue to advocate higher than normal levels of cash, adding gold and owning volatility in mid 2015.” [emphasis added]
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