Bank of America strategists warn that the record rise of the U.S. stock market has put it in a fragile position, and once the Federal Reserve signals dovishness at the Jackson Hole global central bank annual meeting, the market may see a 'buy the rumor, sell the fact' scenario, triggering a round of profit-taking.
The strategy team led by Michael Hartnett pointed out in a report that investors have heavily flocked to risk assets such as stocks, cryptocurrencies, and corporate bonds, based on the logic that they are betting the Federal Reserve will cut interest rates to support a weakening labor market and alleviate the U.S. debt burden.
Hartnett wrote that if Federal Reserve Chairman Powell makes dovish comments at the meeting in Wyoming from August 21 to 23, the stock market may actually decline, as investors will choose to 'buy on the rumor and sell on the fact.'
This warning comes as the U.S. stock market is at historical highs. Driven by tech-heavy stocks, the S&P 500 index has rebounded to a new all-time high, and the mild consumer price inflation data released earlier this week further boosted market bets on a Fed rate cut in September.
The market has preempted rate cut expectations.
Despite the Producer Price Index (PPI) released on Thursday showing that inflation remains hot, causing the market to trim some interest rate cut bets, investor expectations for the Fed's imminent pivot remain high. Interest rate swap traders currently believe the likelihood of a rate cut in September is still as high as 92%.
Hartnett's warning is based on this widespread optimism, namely that the market's positive expectations may have been fully priced into stock prices, and once the good news materializes, it may become an opportunity for investors to lock in profits.
Data on fund flows also corroborates investors' optimistic sentiment. According to a report by Bank of America citing EPFR Global data, approximately $21 billion flowed into U.S. equity funds in the week ending August 13, in stark contrast to nearly $28 billion in fund redemptions the previous week. During the same period, global equity funds attracted over $26 billion and are expected to record the third largest annual inflow in history.
Hartnett has recently warned multiple times that the U.S. stock market may be forming a bubble. He reiterated his view that he is optimistic about international stocks rather than U.S. stocks. Looking ahead, Hartnett believes that as investors seek to hedge against inflation risks and a weakening dollar, gold, commodities, cryptocurrencies, and emerging market assets will be the biggest winners.
