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Bank of America says the current bull market in “everything but bonds” has led to a top-heavy stock market.
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The company monitors 10-year real yields and credit spreads for signals of when this AI-led rally might end.
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BofA says higher yields and tighter spreads could raise recession alarms and trigger a sell-off in stocks.
Bank of America coined a phrase to describe what’s happening in the markets right now, calling it the “everything but bonds” rally.
The company notes that in Q4 2023, stocks and crypto led the way. In the first three months of 2024, it was all about commodities and… well, still crypto. And so far, in the second quarter, that’s when the U.S. dollar has shined.
While this has been lucrative for well-positioned traders across asset classes, BofA warns that it is a byproduct of immense government spending and could eventually unravel if a few conditions keys are filled.
The key is the cohort of ultra-large-cap technology companies that have long dominated stock performance, largely due to their affiliation with AI. BofA says the “everything but bonds” rally has put a particular spotlight on the market’s biggest stocks, with the top 10 accounting for a record 34% of stocks. S&P500 market capitalization, as reflected in the chart below.
But BofA doesn’t see this high-flying bull run lasting forever. The firm outlines a scenario that could derail the rally and ultimately shake the leadership of mega-cap growth stocks: 10-year real yields climb into the 2.5% to 3% region, and/or higher yields combine with higher credit spreads to fuel. recession fears.
The 10-year real yield is currently 2.28%, meaning there is still a long way to go before triggering a possible sell-off of the heavily weighted mega-cap types in the major indexes. According to the chart below, it has not risen above 2.5% since October 2023, and even then, only briefly.
It is also important to consider that mega-cap technology no longer evolves as an ever-unstoppable monolith. There have been bifurcation in the AI-focused actions of the Magnificent Seven as Tesla and Apple have had a rough start to 2024, while heavyweights like Nvidia and Microsoft have shown no signs of slowing down. Then there’s Meta, which is up more than 40% this year in earnings, but has taken a hit to its stock price because its growth isn’t fast enough to please investors.
These divergences have reduced concentration risk in a way that could dampen any potential selloff. In the meantime, if you subscribe to BofA’s view, you should watch the 10-year real yield to know when such a slowdown will occur.
Read the original article on Business Insider
