Don’t Trust This Stock Market Rally. Strategists See More Trouble Ahead.

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The

S&P 500’s
15% summer bounce off its June lows may be as fleeting as the relief from the heat a weekend at the beach provides.

Bank of America strategists told clients in a note on Thursday that they don’t see enough signposts to signal the end of a bear market. Instead, there are signs of trouble ahead—enough to recommend investors to be more strategic rather than jumping in.

The BofA team sees multiple reasons for caution. While there is a view on Wall Street that if everyone is bearish, it’s time to buy, these strategists don’t see that sentiment on Main Street. U.S. households represent $38 trillion in assets, or about 52% of the U.S. equity market, and these folks have not yet begun to sell.

“Households bought $5.9 trillion in equities over the past two years through the end of the first quarter 2022, with inflows recorded in every quarter since Covid,” the strategists write. “Historically, the past three major market lows have occurred 1-2 quarters after substantial household investor selling.”The “big” money, or institutional investors, are also still buying as private markets see robust fundraising. Private markets raised $800 billion so far this year—a pace on track to hit $1.4 trillion by year-end, according to Preqin. These types of inflows across both public and private markets is yet another sign for the BofA team that the market hasn’t seen “liquidity constrained ‘panic’ “ that typically comes alongside the end of a bear market.

Only 30% of the indicators that typically light up before market bottoms are triggered today, according to Bank of America equity and quant strategist Savita Subramanian, who wants at least 80% of the usual signposts to be flashing green.

For example, earnings estimates are still up 7% since the market peak. They typically fall 19% on average at market lows. During the last five recessions, the S&P 500 bottomed after estimates were cut, except in 1990, when forward earnings per share remained flat, she notes.

The Fed is also another concern. Economist Ethan Harris worries that higher stock prices, tighter credit spreads and lower bond yields is the opposite of what Chairman Jerome Powell and crew want to see since it undercuts their fight against inflation. The more resilient growth and inflation is, the further the Fed will have to go with rates to cool things off.

So what should investors do?

BofA strategists recommend clients use what they see as bear market rallies to sell a bit to build up cash or rotate into higher quality stocks with strong and stable free cash flows and dividends. “Keep dividend and bond coupon reinvestments paused and use tax-loss harvesting techniques ahead of better buying opportunities this year,” the strategists write in a note to clients.

Bank of America’s Michael Hartnett’s advice: “Nibble” if the S&P 500 reaches 3600, “bite” at 3300, and “gorge” at 3000. That is a ways away from the index’s current 4241.33.

For now, Hartnett sees inflation as too high for the Fed to pivot. That would likely require weaker payroll data under 100,000 jobs, peak inflation with consumer price index logging 0.0% to .2% month over month increases, higher volatility with the high yield spreads topping 600 basis points, oil getting below $80 a barrel and a steeper Treasury curve.

Write to Reshma Kapadia at [email protected]