Last weekend we highlighted the most stunning divergence observed since the great financial crisis: non-US equity markets have underperformed the US the most over a 3-month period since the failure of Lehman, a divergence which Bank of America said"is reaching levels normally only exceeded in bear markets".

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This divergence, which has been observed across many other asset classes including commodities, Chinese stocks, European banks and others which have recently entered (and in many cases remained) in so-called "rolling bear markets", is highlighted in the latest note by BofA's Michael Hartnett who writes that global stocks ex-US tech are now down -6.2% YTD, while no less than 809 of 1150 EM stocks have entered a bear market.

But it's not stocks that BofA is worried about, it's bonds, and specifically, US investment grade BBB bonds which are annualizing a 3.2% loss (2nd worst since 1988), and which to Hartnett is the true "canary".

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And if the "canary" is indeed singing - if remains ignored by US stock markets - there is one reason, and it's very simple: according to Hartnett one should "Buy when the central banks buy, sell when…"

Indeed, so far the tailwind from global QE is still here and has resulted in record global EPS, 4% US GDP, $1.5tn US tax cuts, $1tn stock buybacks... yet poor 2018 returns.

The reason is a familiar one: the liquidity supernova is going into reverse, i.e., the "end of excess liquidity:"

End of excess returns: CB’s bought $1.6tn assets in 2016, $2.3tn 2017, $0.3tn 2018, will sell $0.2tn in 2019; liquidity growth turns negative in Jan’19 for 1st time since GFC.

Which brings us back to the topic of rolling bear markets, or as Hartnett dubs it: "Bitcoin to Popcoin", or a world in which the bursting of the Bitcoin bubble may have been the first domino:

XBT 1st FX crash of 2018…TRY, VEF, ARS, IDR, BRL, ZAR…Great EM Currency Crash of 2018 (Chart 6) to revive EM in 2019, but autumn risk is EM contagion via FX, spreads & EPS to Europe and finally US.

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BofA once again reminds us of its favorite crisis indicator: the collapse of the Brazilian Real, writing that the Euro is at highs vs BRL, which "historically coincides with financial event (Chart 1)".

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And while the divergence observed between the US and the rest of the world may appear unique, it has happened on various occasions in the past, most notably in 1998.

Which brings the next question: Is the current market redux of 1998? To Hartnett the answer is yes for the following reasons:

• Fed tightening,
• US decoupling,
• flattening yield curve,
• collapsing EM,
• underperforming levered quant strategies

All of these echo ’98; but one thing is missing: global contagion.

For those who may not remember - or have been born - back in 1998 it was Japan that spread Asian crisis in ’98 (China):

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Fast forward 20 years when the BofA CIO believes that this time Europe will be the epicenter of the 2018 global contagion, with the collapse in foreign orders of German capital goods -12% past 7 months – a harbinger of what is coming.

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And if the foreign orders from Germany are the "canary", BofA predicts that a volatile autumn surge in the Euro - as EU investors repatriate - would "indicate EM morphing into global deleveraging event".

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And if Euro repatriation in Europe is the 1st vector of contagion, BofA predicts that the second, and far more obvious one, is simply debt, or Credit contagion:

Credit spread widening the 2nd vector of contagion:

watch credit spreads in excessively indebted Europe (credit/GDP258%), China (credit/GDP 256% = record), EM (record credit/GDP 194%), US IG BBB ($4.93tn outstanding, up from $1.08tn ’08)."

In conclusion, Hartnett asks rhetorically if there has "ever been an investment acronym that didn’t end in a bubble" and notes that 4 of 8 FAANG+BAT stocks are now in bear market territory. This will also point the way to the end of the upcoming global contagion which "ends with investors selling what they own & love (see tech flows below), jump in systemic risk & the Fed blinking".

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