Bank of America strategist Michael Hartnett has reiterated his call to sell US stocks, citing concerns over a potential bubble in the technology and artificial intelligence (AI) sectors. Hartnett also highlights the risk posed by rising bond yields and suggests that the Federal Reserve’s rate hikes may not be over. This blog post examines Hartnett’s recommendations and the factors contributing to his cautious outlook on US stocks.
Tech and AI Bubble Concerns
Hartnett argues that the technology and AI sectors are forming a bubble. While he acknowledges that the current state of AI is a “baby bubble,” he believes that historically, bubbles have emerged with the presence of easy monetary policy and have eventually burst when rate hikes were implemented. Hartnett refers to the example of the 1999 internet stock rally, which led to an economic upswing and subsequently triggered the Fed to tighten monetary policy. Nine months later, the tech bubble burst.
Potential for Further Rate Hikes and Rising Bond Yields
The Bank of America strategists led by Hartnett express concerns that if the Federal Reserve “mistakenly” pauses rate hikes this year, it could result in bond yields rising above 4%. They caution that if this were to occur, it would suggest that the last rate hike of the cycle has not yet been seen. Recent discussions around the US debt-ceiling debate have contributed to a surge in the 10-year US Treasury yield, which stood at approximately 3.6% at the time of the note.
Contrarian Outlook: The “Pain Trade”
Hartnett suggests that the biggest “pain trade” in the next 12 months would be if the Fed funds rate were to rise to 6% instead of falling to 3%. The market currently expects rate cuts, and such a scenario would catch investors off guard. Hartnett believes that the market’s expectations for rate cuts contrast with the potential for further rate hikes, which could lead to a significant shift in sentiment.
Market Performance and Fund Flows
Despite these concerns, US equities rallied on Thursday as optimism surrounding the resolution of the debt-ceiling standoff outweighed worries about the Fed’s rate-hiking campaign. The Nasdaq 100 reached its highest level since April 2022, reflecting the tech-heavy index’s strong performance this year, up 26%. However, Bank of America reports that while tech stocks continue to attract inflows, financials experienced outflows for the third consecutive week, and real estate investment trusts (REITs) saw their largest withdrawals since November 2022.
Fund Flows and Investor Sentiment
Bank of America’s data from EPFR Global reveals that equity funds experienced outflows of $7.7 billion in the week through May 17, while bonds have seen consistent inflows over the past eight weeks. This shift in fund flows suggests that investors are becoming more cautious about equity investments and are seeking the relative safety of bonds.
Bottom line
Bank of America strategist Michael Hartnett’s recommendation to sell US stocks, driven by concerns over a potential bubble in the tech and AI sectors, highlights the ongoing debate surrounding market valuations and monetary policy. While the current state of AI is considered a “baby bubble,” historical precedents and the risk of rising bond yields contribute to Hartnett’s cautious outlook. As market dynamics and investor sentiment evolve, it will be crucial to monitor the impact of the Fed’s rate decisions and the performance of tech stocks in the coming months.
