Bank of America lays out the scenario for the next big selloff - and it hinges on one key thing
- Bank of America Merrill Lynch published the results of its monthly fund-manager survey, and found one indicator moving in the wrong direction to support risk assets.
- The firm lays out its scenario for the next bout of risk selling, pinning it largely to one key driver.
There's an old saying that "cash is king." And judging by Bank of America Merrill Lynch's latest forecast, that may very well be true for the market right now.
Michael Hartnett, BAML's chief investment strategist, says conditions are ripe for a sell off, with one major caveat - investor cash levels have to fall below a key threshold first.
Beyond that, all the classic signs of overexuberance are present, according to the firm's latest monthly fund-manager survey, which includes 223 panelists who manage $643 billion.
First off, 80% of respondents say equities have yet to peak, which is troublesome considering most of Wall Street thinks we've already entered the final stage of the current cycle. Secondly, and by that same token, only 8% of those surveyed see a recession in the next 12 months. Third, one-third of fund managers think companies are carrying too much debt, the highest percentage since 2009.
Then there's the added kicker of BAML's macro indicator slipping into negative territory for the first time since November 2016 (as indicated by the chart below).
All of these forces are combining to create a situation where once cash balances drop a little more, risk assets market-wide will be subject to a fresh batch of weakness. More specifically, BAML finds that fund manager cash levels decreased to 4.9% from 5.0% in May, and forecasts selling if holdings fall below 4.6% in June. Cash balances throughout history are reflected by the gray bars in the chart below.
Of course, BAML is looking at other drivers besides cash. The firm is also closely watching the 10-year Treasury yield, which it says will spur a reallocating from stocks into bonds once it climbs above 3.6%.
Considering the 10-year was trading just a shade over 3% on Tuesday, it still has a ways to go. So if you're going to prioritize one stock headwind to keep an eye on, you'd be best advised to choose cash.
