Bank of America's Hartnett: Market is focused on the possibility of a big rally in US stocks to "welcome the new year", the only risk is that the market is "too optimistic"

Bank of America strategist Michael Hartnett said in his latest outlook report that the market has already begun to position itself for strong economic growth in 2026. Investors generally expect that rate cuts, tax cuts, and tariff reductions will collectively drive accelerated corporate earnings growth. However, the bank's bull/bear sentiment indicator has now risen to 8.5, reaching a reverse "sell" signal for risk assets, reflecting that current market sentiment may be overly optimistic and caution needs to be exercised about the potential adjustment risks. Capital flows highlight market exuberance. The latest data shows that global equities attracted $98.2 billion in inflows in a single week, with US stocks attracting $77.9 billion, marking the second-largest inflow in recorded history. At the same time, funds flowed out substantially from cash assets, totaling $43.9 billion, the highest since April of this year. Hartnett believes that with expectations of fiscal and monetary easing, the probability of a market rise next year has significantly increased. The Fed's continued rate cuts, the launch of a new round of "QE lite" policies, and ongoing CPI inflation continuing to fall provide support for the market. However, he also warns that current sentiment is extremely optimistic and caution is needed regarding the short-term adjustment risks. In terms of allocation recommendations, he leans towards positioning for the downward trend in inflation through long zero-coupon bonds, mid-cap stocks, and emerging market stocks, rather than simply following the current widespread bullish consensus on risk assets. Record high inflows into US stocks The market is currently undergoing a significant reallocation of funds. The stock market has become the main destination for funds, with a net inflow of $98.2 billion in a single week, of which US stocks attracted $77.9 billion, marking the second-largest inflow in recorded history, second only to the $82.2 billion in the week of December 18, 2024. In contrast, the bond market has shown mediocre performance, with only $7.9 billion in inflows; gold saw an increase of $3.1 billion. It is worth noting that cryptocurrencies experienced outflows for the first time in nearly four weeks, totaling approximately $500 million, but analysts generally expect this trend to be unsustainable and may reverse in the short term. The main source of this round of fund reallocation is the substantial outflow from cash assets. Data shows that investors withdrew $43.9 billion from cash in a single week, the largest since April of this year, reflecting a significant increase in market risk appetite. 2026 trading strategy: Betting on downward inflation Bank of America strategist Michael Hartnett has constructed a macro trading framework for the first half of 2026. In an optimistic scenario, if CPI falls to 2% and the 10-year US Treasury yield drops to around 3.5%, risk assets are expected to receive significant support. The report also points out several potential risks: global liquidity may be nearing its peak, the Fed's rate cuts may be less than the market's current expected 150 basis points, perhaps not even reaching 80 basis points, and there is a possibility of the Bank of Japan's policy interest rate reaching its highest level since 1995. However, several structural factors may offset the above risks. These factors include the possibility of the Fed unexpectedly restarting quantitative easing, a downward trend in oil prices, economic measures adopted by the Trump administration before the midterm elections to alleviate pressure on people's lives, and the continued tilt of the labor market towards employer dominance. These factors all help to lower inflation, interest rates, and the level of the US dollar. Bull/bear indicator issues warning signal Despite a positive outlook, Bank of America's bull/bear sentiment indicator has risen from 7.9 to 8.5, reaching the threshold for a reverse sell signal for risk assets. A reading above 8.0 typically indicates that market sentiment has entered an extremely optimistic range, which has historically signaled short-term pressure for adjustments. Since 2002, this signal has occurred 16 times, with the global stock index (ACWI) averaging a 2.4% drop after the signal. Statistics show that the maximum drawdown in the month, two months, and three months following the signal reaching 4%, 6%, and 9%, respectively, while the potential maximum gain missed during the same period generally remains below 2%. However, the historical accuracy of this indicator is about 63%, and the last two signals have shown significant deviations. After issuing sell signals in December 2020 and July 2024, the stock market did not retreat but continued to strengthen. Structural market risks are starting to emerge Although overall market positions have not shown signs of overheating, some structural risks are accumulating. Margin debt growth continues to outpace market gains, hedge fund leverage remains high, and momentum trading has been going on for an extended period. The current concentration of investor positions in AI and technology sectors is reminiscent of market structures in 2000 and 2007. At the same time, market short positions remain crowded, cash allocations have dropped to historical lows, and this change is occurring just as corporate stock buybacks are about to enter a quiet period and the support from large buyers may weaken. Of particular concern is the general upward trend in global long-term yields, which poses a risk that cannot be ignored. Even if the Fed continues to push for rate cuts, US long-term rates may rise due to global factors, leading to increased bond market volatility and posing a substantial threat to the stock market. This article is sourced from "Wall Street News," written by Li Jia, and edited by Chen Qiuda.