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Michael Hartnett warns of potential stock market bubble due to high valuations and low volatility.
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Fed rate hikes and rising inflation are key risks that could pop the potential stock market bubble.
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Hartnett advises investing in bonds, consumer staples, financials, and healthcare post-bubble.
By now, investors have explored the AI bubble question ad nauseam. But as the market continues to shoot to record highs, is the topic worth revisiting?
Bank of America strategist Michael Hartnett seems to think so, pointing out several worrying signs in a note to clients on Friday, like:
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“Exponential price action” in the stock market
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High valuations — the S&P 500’s 12-month trailing PE is in the high 20s
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Extreme market concentration, as the top 10 stocks make up around 40% of the S&P 500
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Only 21 stocks in the S&P 500 (4%) at new highs despite the index at record levels — at the dot-com peak, it was 20 stocks, Hartnett said
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331 stocks in the S&P 500 are trading at least 20% below their all-time highs
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Bank of America’s Bull/Bear Indicator rising to 8.5, showing “extreme bullish” sentiment, which the bank says is a contrarian sell signal
The main risk that would pop a bubble — if there indeed is one — is Fed rate hikes, Hartnett said. And as rising oil prices push up inflation, that risk is certainly real. According to the CME FedWatch tool, markets are pricing in a 44% chance that the fed funds rate is at least 25 basis points higher by the Fed’s December meeting.
With the context of the above figures, Hartnett sent clients a post-bubble investing playbook, drawing from the periods following past manias like the Roaring 20s, the dot-com bubble, Japan’s bubble in the 1980s, and China’s property boom around 2007.
“Post-bubble investor roadmap since 1929 is long bonds, and long combo of defensives and/or sectors which dramatically underperformed in the last months of the bubble,” Hartnett wrote.
What does that mean for today? Hartnett said consumer staples, financials, and healthcare stocks should outperform. He also highlighted small-cap tech and growth stocks as the AI trade swings toward benefitting adopters.
Examples of funds that offer exposure to these trades include: the Vanguard Consumer Staples ETF (VDC), the iShares U.S. Financials ETF (IYF), the Health Care Select Sector SPDR Fund (XLV), and the Invesco S&P SmallCap Information Technology ETF (PSCT).
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