Bank of America's Hartnett: "Tactically" Bearish, but "Strategically" Bullish, as Policymakers Won't Allow a Market Crash

Original author: Bu Shuqing

Original source: Wall Street CN

Michael Hartnett, Chief Investment Strategist at BofA Securities, presents a seemingly contradictory yet logically coherent market assessment in the latest Flow Show report: maintain near-term caution and recommend exiting risk assets; however, from a long-term strategic perspective, he maintains a "long equities, short bonds" allocation, with the core rationale being that U.S. policymakers now view the stock market as a systemically important asset that is "too big to fail."

On the latest developments, the BofA Bull & Bear Indicator has risen from 9.4 to 9.7, the highest level since the meme stock bubble in early 2021, reflecting extremely optimistic market sentiment.

Meanwhile, Hartnett warns that credit markets are emitting increasingly bearish signals, with credit spreads and CDS for AI hyperscale data center operators continuing to widen, while tech stock fund flows have turned negative for the first time in six weeks.

For investors, this dual-track assessment of "tactically bearish, strategically bullish" implies: rotate toward defensive assets and duration assets in the near term, but there is no need to be overly pessimistic about the long-term market outlook—unless a key reversal signal of "rising yields and falling bank stocks" emerges.

Bull & Bear Indicator Hits Five-Year High, Overheating Sentiment Risk Rises

The BofA Bull & Bear Indicator has risen to 9.7, its highest reading in nearly five years, driven primarily by massive inflows into high-yield bonds, narrowing spreads on global high-yield and AT1 risk bonds, and improving breadth across global equity indices.

Hartnett notes that historically, whenever this indicator has approached similar extremes—whether in 2018, 2020, or 2021—market sentiment has typically reversed sharply from extreme optimism to extreme pessimism within the following year. He does not assert that history will necessarily repeat itself, but he explicitly cautions that this pattern warrants attention.

Looking at this week's fund flows, nearly all asset classes recorded net inflows: cash saw $53.7 billion in inflows, equities $32.9 billion, bonds $23.1 billion, gold $0.9 billion, and cryptocurrencies $0.6 billion.

Among these, U.S. equities saw annualized inflows of $652 billion, a record high; investment-grade bonds saw annualized inflows of $527 billion, also a record high.

Short-Term Tactics: Retreat and Rotate, Not Add

On short-term operational positioning, Hartnett explicitly states he remains in the "summer retreat/rotation rather than adding" camp, advising investors to exit risk assets and rotate into defensive assets (such as consumer staples), duration assets (such as REITs, small caps, biotech), and the U.S. dollar.

His logic is that these assets have greater resilience to continued tightening of financial conditions and are less exposed to disappointment in the market's prevailing consensus of "no hard macro landing, no Fed rate hikes, no cuts to AI capex, and no Democratic midterm sweep," compared to cyclical sectors such as banks, industrials, and semiconductors.

On the macro data front, Hartnett had previously predicted that if July nonfarm payrolls exceeded 125,000 and the unemployment rate came in below 4.1%, Fed chair candidate Kevin Warsh could turn hawkish again at the Jackson Hole symposium on August 28; conversely, if nonfarm payrolls came in below 50,000 and unemployment exceeded 4.3%, that would favor duration assets and defensive positioning.

The final data released presented a mixed picture—nonfarm payrolls significantly missed expectations, but the unemployment rate fell to 4.1%, partially offsetting the negative impact, despite the labor force shrinking by 264,000 over the same period.

Long-Term Strategy: Policy Backstop Makes Equities "Too Big to Fail"

From a strategic perspective, Hartnett maintains his core "long equities, short bonds" allocation, arguing that policymakers have made it clear they will not allow a significant stock market decline. He points out that the U.S. economy is currently highly dependent on the wealth effect—U.S. household equity holdings have increased by $7 trillion so far this year, following gains of $9 trillion in each of 2024 and 2025—as well as the AI data center capex boom.

Last week's coordinated intervention in the foreign exchange market—aimed at ending what Hartnett calls the "poor man's LTCM" deleveraging event—further confirms this assessment: the U.S. government will always step in to prevent tightening financial conditions from ending the boom and the bubble. He adds that the Trump administration and Treasury Secretary Scott Bessent still hold yield curve control as a card in their hand.

On the earnings front, Hartnett acknowledges that EPS is the core engine of the current bull market, with 12-month forward EPS expectations revised up by 33%, partly thanks to approximately $35 billion in tariff refunds over the past three months, which has partially offset the roughly $75 billion tariff impact between May and July 2025.

Termination Signals and Tail Risks

Despite his long-term bullishness, Hartnett clearly identifies the conditions that would end the current bull market: if a bond-market self-defense selloff characterized by "rising yields and a falling dollar" emerges, forcing a sharp pivot in fiscal policy and driving asset allocation to shift from equities to bonds, this boom will come to an end.

For the "canary in the coal mine" reversal signal that investors care most about, Hartnett gives a clear answer: "rising yields, falling bank stocks."

In credit markets, he notes that credit spreads and CDS for AI hyperscale data center operators continue to widen, driven by large-scale share buybacks and fading cash flows. He believes that only if MAGS (tech giants) quarterly earnings per share exceed $70 can the threat of "cheap Chinese computing power ending the AI capex boom" be eliminated.

Gold as a Hedge for Political Cycles and Midterm Elections

Hartnett closes the report by zooming out to a broader macroeconomic and political framework.

He points out that political populism in the 2020s has driven fiscal expansion, boosting U.S. nominal GDP from $20 trillion to $32 trillion over the past six years—a 63% increase—while U.S. national debt is about to surpass $40 trillion.

On the political landscape, he characterizes the upcoming midterm elections as a contest between "populist capitalism" (reducing deficits through growth) and an alternative political path (reducing deficits through wealth taxes).

In terms of market implications, Republicans retaining the Senate majority would be a positive; going long consumer stocks is the best strategy to bet on Trump pivoting toward affordability concerns; and going long gold is an effective tool to hedge the tail risk of a synchronized selloff in yields, the dollar, and equities triggered by the "K-shaped" voter structure before year-end.