BofA flags further downside risk for stocks, yields and dollar

Investing.com -- Bank of America strategists say they stay "tactically risk-off" until mid-November, expecting stocks, Treasury yields and the U.S. dollar to fall further before the market finds a floor.

Strategists led by Michael Hartnett expect 30-year Treasury yields to drift toward 5% and the dollar index to dip below 100. They said the move continues until three things happen — a Democratic midterm sweep is fully priced in, the European Central Bank and French government stop the rout in French bonds, and an AI capex cut or an extreme equity issuance announcement marks a peak in hyperscaler debt spreads.

A Democratic sweep would be negative for earnings, the strategists said, because it would end the lower tax and regulation regime and leave Trump less able to steer capital toward the U.S.-China AI race. Polymarket now puts the odds of a sweep at 68%.

On the upside, they flagged U.S. peace deals on Russia, Ukraine or Iran that cut oil prices by $10 to $20 a barrel. The near-term downside risk is hyperscaler bond spreads surging above 200 basis points, which could force investors to deleverage on shadow-banking credit fears.

Looking to 2027, the team laid out three scenarios: an AI bubble, a Goldilocks broadening of the stock rally, and a deflationary bust. They said investors’ conviction in the first two is too high and fear of a hard landing is too low. In BofA’s October fund manager survey, 50% expect no landing, 40% a soft landing and 6% a hard landing.

The bubble case rests on AI resembling the 19th-century railroads and on an unprecedented U.S. government backstop for AI. The breadth case rests on consensus forecasts of a 40 basis point drop in Treasury yields and 15% S&P 500 earnings growth.

The bust case draws on railroads, which had three drawdowns of 30% to 50% during their boom. It also leans on the risk that credit tightening forces cuts to the $1.2 trillion of hyperscaler capex forecast for 2027. The strategists see downward revisions coming to 2027 forecasts for 5% U.S. nominal GDP growth and 43% global tech earnings growth.

The BofA Bull & Bear Indicator dipped to 7.2 from 7.4, in neutral territory after "extreme bull" readings all summer. The next big entry point for risk assets comes when policymakers are forced to ease financial conditions, and fear becomes more visible, the strategists said.

In terms of market strategy, the strategists said they are adding to "peak yield" plays including small caps, REITs, utilities and consumer discretionary. They pointed to capitulatory outflows from utility and discretionary funds this week.

In recent fund flows, equity funds drew $55.6 billion in the week to Oct. 21, money market funds $28.8 billion, bonds $12.1 billion and gold $2.6 billion. Crypto funds took in $200 million.

Emerging market stocks led, with $33.5 billion in a fourth week of inflows. China equities drew $17 billion and Korea $5.8 billion, both the largest since July. Tech funds took in $18.8 billion, also the biggest since July.

Consumer funds lost $2.1 billion, the largest outflow since February 2014 and the second largest ever. Utilities lost $1.6 billion, the largest since March 2015 and also the second largest on record. Energy funds drew $1.1 billion, the most since April.

U.S. equities saw a third week of inflows at $6.7 billion, and Japan a second week at $6 billion. Europe saw a second week of outflows at $1 billion.

Treasuries drew a 17th week of inflows at $5.4 billion, and emerging market debt a 12th week at $4 billion. Investment-grade bonds saw a fifth week of inflows at $1.5 billion, and bank loans a seventh at $1.5 billion. High-yield bonds saw a fourth week of outflows at $500 million.

Original Article

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