In his latest 'Flow Show' research note (August 8, 2024), BofA Research Investment Strategist, Michael Hartnett points to the importance of monitoring interest rate policies ("sell upon first rate cut"), technical market levels ("could shift Wall Street’s narrative from a soft to a hard"), and investor sentiment ("frazzled"). In the note he suggests strategic positioning in assets likely to benefit from potential rate cuts and highlights specific opportunities in distressed markets and sectors. The overarching theme is cautious optimism with a focus on navigating potential volatility and market shifts.
Economic and Market Overview
- Interest Rates and Monetary Policy: The Bank of Japan (BoJ) has shown conflicting stances on raising policy interest rates, with a recent shift indicating they will not hike rates when markets are unstable. Wall Street's current goal is to push the Federal Reserve into significant rate cuts.
- US Prime Rate: The real US prime rate for small businesses is at 6.5%, the highest this century, which is slowly impacting the US consumer and labor market. Global rate cuts are now seen as necessary, with significant cuts required for effectiveness.
- China's Bond Yields: China’s 30-year government bond yield has reached an all-time low, indicating potential economic stress and a need for stimulus.
Market Sentiment and Flows
- Investor Sentiment: Investor sentiment is described as "frazzled," with a consensus that there is a high probability of a soft landing if the Fed cuts rates. This sentiment favors stocks over bonds and cyclicals over defensives.
- Weekly Flows: There have been significant inflows into cash ($80.8bn), bonds ($10.0bn), and stocks ($9.7bn), with notable outflows from gold ($0.5bn).
- High Yield Bonds and Bank Loans: Both saw their largest outflows since October 2023 and March 2020, respectively, suggesting a shift away from riskier assets.
Investment Strategies and Opportunities
- "Sell the First Cut" Strategy: Hartnett suggests selling upon the first rate cut, as leadership in AI and related sectors is expected to struggle until earnings gains become more visible.
- Opportunities in Distressed Assets: Assets that have been constrained by high yields, such as government bonds, REITs, small caps, and some emerging markets (e.g., Brazil), are seen as having relative opportunities as yields potentially drop to 3-4%.
- Housing Markets: Significant opportunities are identified in housing markets in countries with floating mortgage rates like the UK, Canada, Australia, New Zealand, and Sweden, where rate cuts can quickly stimulate economic activity.
Technical Levels and Market Indicators
- Critical Technical Levels: Key technical levels that could shift Wall Street’s narrative from a soft to a hard landing include 4% on the 30-year Treasury, 400 bps on HY CDX, and 5050 on the S&P 500. Maintaining these levels is crucial for market stability.
- BofA Bull & Bear Indicator: This indicator has dropped to 6.3 from 6.6, reflecting a neutral stance but highlighting worsening stock index breadth and high-yield bond outflows.
Sector and Regional Insights
- Sector Flows: Significant inflows have been noted in tech ($3.3bn) and utilities, while outflows have been seen in financials, healthcare, consumer staples, and materials.
- Regional Flows: Japan has seen the third-largest inflow year-to-date, while Europe has experienced significant outflows, indicating regional shifts in investor sentiment.
Footnote: [1] BofA-Hartnett-The-Flow-Show-The-Prime-of-Strife_20240808.pdf
