Big money investors are defying Bank of America as they freak out about a possible recession
- Big fund managers are increasingly sounding the alarm on a possible recession, according to data compiled by Bank of America Merrill Lynch.
- The firm explains why this conflicts with its core economic view, and warns against fleeing the market too soon.
As equity markets bounce back from their latest bout of turbulence, it may seem like investors are feeling confident about the prospect of further gains.
But beneath the surface, Bank of America Merrill Lynch finds that the market's biggest money managers are already positioning as if a major economic downturn is near. The firm's findings come from its latest monthly fund manager survey, which includes more than 200 panelists who manage a combined $646 billion.
As the BAML chart below shows, more than 75% of surveyed investors think the economy is now in the late stages of expansion, the highest percentage in at least a decade. And, perhaps even more notably, the number has surged since the start of 2018.
Going beyond the survey results, BAML has observed investors behaving in late-cycle fashion. The most obvious example of this is the weakness seen in so-called cyclical stocks on any signal that earnings growth is peaking.
This makes sense when you consider how crucial profit expansion has been to equity gains throughout the nine-year bull market. A slowdown poses a great threat to this all-important backstop, and can therefore be viewed as a major threat.
And BAML gets where these fund managers are coming from, even if they don't fully agree with their late-cycle thesis. After all, the firm notes, the economy is now in its 10th year of expansion, making it the second-longest since World War II.
"The reaction of cyclical stocks to any sign that earnings might be peaking is a clear sign that investors are concerned about the cycle," James Barty, the firm's head of global cross-asset and European equity strategy, wrote in a client note. "The concern about the duration of the cycle is driven primarily by the length of the US economic expansion."
But just because BAML understands where large fund managers are coming from doesn't mean they agree. In fact, the firm is adamant that the US equity market still has some strong months ahead of it. One big argument of BAML's is that the circumstances surrounding this cycle differ from past instances.
"This cycle has been very different with slower growth so the US output gap is only just closing," wrote Barty. "That suggests inflation will rise only slowly from here and the Fed is able to tighten gradually and keep real rates low. With equity valuations about in line with history (15x for global equities) earnings growth should continue to translate into higher equity markets."
Ethan Harris, BAML's chief economist, agrees. According to Barty's report, he "does not see the normal type of excesses that would be associated with the end of the cycle."
With all of that considered, one question remains: What's the big deal? BAML argues it can actually be quite costly for investors to prematurely throw in the towel on an economic cycle.
For evidence of that, look no further than the MSCI All-World index. It's historically surged 44% during the last two years of a stock bull market, and 22% over the final 12 months.
"Clearly we are later cycle, but that does not mean we are at the end of the cycle," said Barty. "The difference is crucial for investors."