The risk of a “flash crash” in markets is rising, strategists at Bank of America Merrill Lynch said on Friday, after a week in which previously-booming cryptocurrency Bitcoin tumbled, oil sank, and investors piled into stocks perceived as safer.
Rising volatility across a range of asset classes and rapid deleveraging like that seen in oil markets in recent weeks are signs a bear market could have further to go, they said.
Brent crude hit an eight-month low on Tuesday in its steepest one-day fall in more than three years and Bitcoin hit a 13-month low on Thursday, the latest assets to fall sharply.
“Sell rallies,” strategists at the U.S. bank advised clients, saying that despite sharp falls in the stock market, positioning by institutional investors was not pessimistic enough to signal the market could be at rock bottom.
“Ingredients of flash crash rising ... bond, FX, equity volatility all trending up, vicious deleveraging events, dislocation risk via abnormal spreads ... triggers could be violent U.S. dollar move and/or shock macro data forcing abrupt GDP and earnings downgrades,” they wrote.
The bear market has been such that cash has outperformed stocks and bonds this year for the first time since 1992, the strategists said, noting that despite this $122 billion has flowed into equities, $35 billion into money market funds, and $24 billion into bonds.
This week saw modest inflows of $4.6 billion into equities, while bonds suffered outflows of $5.2 billion, EPFR data showed.
Corporate bonds saw big outflows - investment grade corporate bond funds lost $2 billion and high-yield bond funds lost $2.3 billion.
Indeed, the next assets to drop could be high-yield credit and the U.S. dollar, BAML reckoned, which is up 5.1 percent year-to-date.
The “last bulls standing” are high-yield corporate bonds, the strategists wrote, and the U.S. dollar - which they see climbing further into the end of this year and first quarter of 2019 before falling.
In terms of regional flows, investors pulled $1.3 billion from European equity funds, which have seen outflows for 35 of the past 36 weeks.
U.S. equities, the world leaders in terms of performance and valuations, saw $2.6 billion of inflows.
A nascent appetite for emerging market stocks was visible, with $1.2 billion going into the region, its fifth straight week of inflows.
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Apple (AAPL.O), which BAML strategists labeled the “king of buybacks”, has cracked, they said, as the stock fell to below its 200-day moving average, a level seen as important for sentiment.
Apple shares are on course for their worst month since April 2016, and have suffered seven consecutive weeks of losses as the iPhone maker’s weak results and stress in the semiconductor space dented the stock.
Its recent decline signals share buybacks - which have been a key driver of the rapid rise of U.S. stocks - are no longer sufficient to fuel the market.
This year has seen a record $800 billion of U.S. buybacks so far, yet the S&P 500 buyback index - which tracks the performance of the 100 stocks in the index with the highest buyback ratios - is up just 0.9 percent year-to-date, and down 5.9 percent this quarter.
The recent decline of U.S. tech stocks like Apple which had led the market higher is one symptom of a building rotation from “growth” stocks into “value” stocks, further evidenced this week with $1 billion flowing into value-focused funds and $0.6 billion leaking out of growth-focused funds.
Defensive - steady revenue and high dividend yielding - sectors like healthcare and utilities also led the way in terms of inflows. Some $1.1 billion poured into healthcare funds and $700 million into utilities funds.
Financials funds, meanwhile, saw $1.2 billion of outflows.
Reporting by Helen Reid; Editing by Mark Potter