BofA's Hartnett: "Tactical" bearish but "strategic" bullish because policymakers will not allow a market crash.

Michael Hartnett, Chief Investment Strategist at Bank of America Securities, proposed a seemingly contradictory yet logically consistent market judgment in the latest issue of the Flow Show report: maintain caution in the short term and recommend withdrawing from risk assets; however, from a long-term strategic perspective, he maintains a positioning of "long stocks, short bonds." The core logic behind this stance is that U.S. policymakers have regarded the stock market as a "too big to fail" systemic asset. In the latest developments, the Bank of America Bull & Bear Indicator has risen from 9.4 to 9.7, reaching the highest level since the meme stock bubble at the beginning of 2021, reflecting extremely optimistic market sentiment. At the same time, Hartnett cautioned that the credit market is sending increasingly clear bearish signals, as credit spreads and CDS for AI hyperscale data center operators continue to widen, while there has been a net outflow from tech stocks for the first time in six weeks. For investors, this "tactically bearish, strategically bullish" dual judgment means that in the short term, there should be a rotation towards defensive assets and duration assets, but there is no need to be overly pessimistic about the long-term market outlookunless there is a key reversal signal of "rising yields and falling bank stocks." The Bull & Bear Indicator has reached a five-year high, and the risk of overheating sentiment is rising. The Bank of America Bull & Bear Indicator has climbed to 9.7, the highest reading in nearly five years, mainly driven by large inflows into high-yield bonds, narrowing spreads for global high-yield bonds and AT1 risk bonds, and improvement in the breadth of global stock indices. Hartnett pointed out that historically, whenever this indicator reaches similar extremesin 2018, 2020, or 2021market sentiment often swiftly reverses from extreme optimism to extreme pessimism within a year. He did not state that history will necessarily repeat itself but clearly indicated that this pattern is worth noting. In terms of fund flows this week, nearly all asset classes experienced net inflows: $53.7 billion into cash, $32.9 billion into stocks, $23.1 billion into bonds, $900 million into gold, and $600 million into cryptocurrencies. Among these, net inflows into U.S. stocks reached an annualized $652 billion, setting a historical record; investment-grade bonds also saw an annualized inflow of $527 billion, also a historical record. Short-term tactics: retreat and rotation, not increasing positions. In terms of short-term operations, Hartnett emphasized being in the "summer retreat/rotation rather than increasing positions" camp, recommending that investors withdraw from risk assets and shift towards defensive assets (such as essential consumer goods), duration assets (such as REITs, small-cap stocks, and biotechnology), and the U.S. dollar. His logic is that these assets have a stronger resistance to the ongoing tightening of financial conditions and are less affected by the market's mainstream consensus of "no macro hard landing, no Fed rate hikes, AI capital expenditures not being cut, and the Democrats not being swept in the midterms" than cyclical sectors like banks, industrials, and semiconductors. On the macro data front, Hartnett had previously predicted that if July non-farm payrolls exceed 125,000 and the unemployment rate remains below 4.1%, Fed Chair candidate Kevin Warsh could return to a hawkish stance at the Jackson Hole meeting on August 28; conversely, if non-farm data is below 50,000 and the unemployment rate exceeds 4.3%, it would favor duration assets and defensive positioning. The final published data presented mixed signalsnon-farm data fell significantly short of expectations, but the unemployment rate dropped to 4.1%, partially offsetting the negative shock, despite a shrinkage of 264,000 in the labor force population. Long-term strategy: policy support makes the stock market "too big to fail." From a strategic perspective, Hartnett maintains his core positioning of "long stocks, short bonds," reasoning that policymakers have clearly indicated they will not allow a significant drop in the stock market. He pointed out that the current U.S. economy is highly dependent on the wealth effectU.S. households' equity holdings have increased by $7 trillion so far this year, with earlier increases of $9 trillion in 2024 and 2025along with the surge in AI data center capital expenditures. Last week's coordinated intervention in the foreign exchange marketaimed at ending what Hartnett termed the "poor man's version of LTCM" deleveraging incidentfurther underscores this judgment: the U.S. government will always intervene to prevent tightening financial conditions from ending prosperity and bubbles. He also added that the Trump administration and Treasury Secretary Scott Bessent still hold the card of yield curve control. In terms of earnings, Hartnett acknowledged that EPS is the core engine of the current bull market, with forward 12-month EPS expectations raised by 33%, partly due to about $35 billion in tariff refunds over the past three months, which somewhat offset the projected $75 billion tariff impact between May and July 2025. Ending signals and tail risks. Despite a long-term bullish outlook, Hartnett clearly outlined the conditions for the current bull market's conclusion: should a bond market self-defensive sell-off event occur with "rising yields and falling bank stocks," it would force a sharp turn in fiscal policy and shift asset allocation from stocks to bonds, thereby ending this round of prosperity. For the investors most concerned about the "canary in the coal mine" reversal signal, Hartnett provided a clear answer: "rising yields and falling bank stocks." In the credit market, he noted that the credit spreads and CDS for AI hyperscale data center operators continue to widen, due to the declining stock buybacks and cash flows. He believes that if MAGS (tech giants) report earnings per share exceeding $70, it would eliminate the threat of "China's cheap computing power ending the AI capital expenditure boom." Gold becomes a hedging tool against the political cycle and midterm elections. Hartnett, at the end of the report, shifted focus to a more macro political and economic framework. He noted that the political populism of the 2020s has driven fiscal expansion, causing the nominal GDP of the U.S. to rise from $20 trillion to $32 trillion over the past six years, an increase of 63%, while U.S. national debt is approaching $40 trillion. In terms of the political landscape, he characterized the upcoming midterm elections as a contest between "populist capitalism" (reducing deficits through growth) and another political path (reducing deficits through wealth taxes). In terms of market implications, the Republican party retaining a majority in the Senate would be favorable; going long on consumer stocks would be the best strategy to bet on Trump shifting focus to affordability; while going long on gold would serve as an effective tool to hedge against the tail risk of a "K-shaped" voter structure leading to synchronized declines in yields, the dollar, and the stock market before the end of the year. This article is reproduced from "Wall Street Insights," authored by Bu Shuqing; GMTEight editor: Liu Jiayan.