Key Takeaways: Bank of America's proprietary sentiment gauge climbed to 9.7, its most extreme bullish reading since 2021, prompting the bank to urge investors to trim exposure to risky assets.
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BofA warns market euphoria hits extreme as gauge nears 2021 high
Bank of America's Bull & Bear gauge rose to 9.7, its highest since 2021, as the bank urged investors to trim risky assets. The reading, up from 9.4 and within three-tenths of the maximum 10, reflects strong equity momentum, heavy credit inflows and tighter spreads across global markets.
"Investor bullishness has become so extreme that it's time to start reducing exposure to risky assets," said Michael Hartnett, chief investment strategist at Bank of America.
Capital flows reinforce the picture of elevated risk appetite. Equity funds attracted $32.9 billion in the latest week, with exchange-traded funds accounting for $40.1 billion of inflows and U.S. stock funds taking in $9.6 billion. Investment-grade bond funds drew $10.2 billion, while high-yield corporate bond funds recorded $4.1 billion of inflows, their strongest weekly intake in more than two years.
The warning comes as global equities trade near record highs, leaving markets more vulnerable to negative surprises. BofA's preferred destinations for rotated capital include consumer staples, real estate investment trusts, small-cap stocks and biotechnology, while commercial banking, industrials and semiconductor stocks face greater sensitivity to valuations and interest rates.
Labor Data Adds to the Case for Caution
The latest labor-market report adds context to the warning. The U.S. economy unexpectedly lost 23,000 jobs in July versus expectations for an 80,000 increase, while May and June payroll growth was revised down by a combined 103,000 jobs. The unemployment rate edged down to 4.1% from 4.2%.
Instead of triggering a selloff, the weak report pushed Treasury yields lower and boosted expectations for Federal Reserve rate cuts, helping the S&P 500 close at a record high. The reaction highlights BofA's concern that investors keep favoring stocks despite softer data, with hopes for easier monetary policy supporting the risk-on trade.
Where BofA Sees Shelter
Against this backdrop, the bank is advising clients to rotate toward defensive sectors, bonds and the U.S. dollar rather than continue aggressively buying the rally. The strategy also flags consumer staples, real estate investment trusts, small-cap stocks and biotechnology as potential destinations for capital moving out of more exposed parts of the market.
The valuation backdrop adds weight to the caution. By one calculation, the S&P 500's cyclically adjusted price-to-earnings ratio sits near 41.4, only a few points below the all-time high reached in the dot-com era and far above the long-run average of roughly 16 to 17. Each prior instance of a steep, rapid rise in the CAPE ratio was followed by a market decline.
The stock market risk flagged by BofA is less about predicting the exact timing of a correction and more about recognizing that investor positioning has become unusually bullish. With the gauge near its ceiling and flows concentrated in risk assets, the margin for disappointment has narrowed.
This article is for informational purposes only and does not constitute investment advice.
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