One month ago, and well before the latest market swings and turmoil, bank of America joined the chorus of "late cycle" warnings, writing that its proprietary "Global Wave" indicator just peaked for only the tenth time in 25 years, noting that in the last month, five of the seven components deteriorated including confidence, market, and real economy indicators.
Commenting on the implications of this inflection point, BofA said that a peak in the Global Wave tends to come with a period of more mediocre returns in equity markets but noted that sustained negative returns are only evident in those episodes that lead to global recession. In the global recessions of 2000 and 2007, the peak in the Global Wave was very close to the peak for the global equity market. Sharply negative returns followed (averaging -14% after six months and -36% after a year).
So what are the consequences for markets? Well, there are good and bad news.
The good news is, or rather would be, if the current global wave peak is not like the peaks observed in 2000 and 2007, in other words if what follows is not a recession. Here is BofA:
Ex of recessions Global Wave peaks point to a pause not end of equity rallies: Stripping out those two recession periods, the average profile for MSCI ACWI shows a market that moves sideways for 6-12 months around the peak in GW. In 2018, we are so far tracking reasonably closely to that pattern, with global equities trading in a range since the correction from the January highs. The typical profile then suggests a bias to the upside six months subsequent to the peak in the Global Wave. 12 months after the non-recessionary peaks MSCI ACWI was on average 11.6% higher.
That said, the average non-recessionary post-peak profile masks a wide range in outcomes historically. As BofA admits, material drawdowns were not uncommon in the non-recession episodes. Notably there were sizable (20% plus) corrections in 1998, 2002, 2011 and 2015. 2002 was really the continuation of the post TMT-bubble bear market so is very different to the other observations or indeed the current episode which all saw strong returns in the preceding 12 months. Additionally, two of the other three episodes were associated with stress in EM (1998 and 2015), while 2011 was centered on the European sovereign debt crisis. Nevertheless, as shown in the chart below, global equities were 10-20% higher 12 months after the peak in Global Wave in five of seven non-recessionary episodes.
Obviously, this implies that the "bad news" is if we are currently trading through a 2000/2007 scenario, because as the next chart shows, in those two scenarios, the average global market return 12 months after the peak was hit, are a chilling -36%: a crash of such a magnitude in the current environment - without central bank intervention...