BofA Strategists Say US Stocks Set For 10% Drop Before Later Rally

(Bloomberg) — US stocks are poised for a fresh slide before ultimately rallying in the second half of the year when economic conditions stabilize, according to Bank of America Corp. strategists.

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Investors are positioned for the S&P 500 to tumble nearly 10% to 3,600 points before rallying 17% to the 4,200 level, strategists led by Michael Hartnett wrote in a note.

Trading during an economic and earnings recession “requires patience,” they said. The “pain trade” will last until a trough in Fed rate forecasts, yields and credit spreads signals “peak Goldilocks” — describing a steady economy that is not running too hot or too cold.

Global stocks gained at the start of this year amid optimism fueled by China’s reopening, cooling inflation and expectations that central banks will take a less aggressive approach to tightening. Still, strategists are increasingly favoring European and Asian shares over US peers against the backdrop of higher rates. Hartnett said the outperformance of European stocks versus the US was the “start of an era” last week while Goldman Sachs Group Inc. peers said the Chinese stock rally has more room to run.

Global stock funds had $7.2 billion of inflows in the week through Jan. 11, according to a separate Citigroup Inc. note citing EPFR Global data. US and European funds had $2.6 billion and $500 million of redemptions, respectively.

“Markets may have good reasons to see the glass half full on inflation and dismiss hawkish” central bank rhetoric, Emmanuel Cau, a strategist at Barclays Plc wrote in a note dated Friday. “More signs of moderating price pressures are now visible in services, not just in manufacturing, and the job market is showing some cracks as well.”

The latest US figures showed inflation continued to slow in December, adding to evidence price pressures have peaked and putting the Federal Reserve on track to again slow the pace of interest-rate hikes.

The focus will soon turn to profits as major US banks including JPMorgan Chase & Co. kick off the earnings season in earnest on Friday. Investors will be scrutinizing companies for how they’ve navigated myriad headwinds including higher rates, elevated prices and slowing demand.

“S&P 500 earnings revisions point to a hard landing” even though the market is pricing a soft landing, Goldman Sachs strategists led by David Kostin wrote in a note late Thursday. If there is no recession, as the team expects, S&P 500 earnings per share growth will be flat this year, they said.

–With assistance from Michael Msika.