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According to Bank of America, the ongoing “everything but bonds” bull market has resulted in a very top-heavy stock market.
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The firm is watching real 10-year yields and credit spreads for signs of when this AI-led rally might end.
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According to BofA, higher yields and tighter spreads could raise recession alarms and trigger a stock sell-off.
Bank of America has coined a term for what’s going on in the markets right now, calling it an “everything but bonds” bull market.
The company notes that stocks and cryptocurrencies led the way in the fourth quarter of 2023. In the first three months of 2024, it was commodities and… well, still crypto. And so far in the second quarter, it has been the US dollar’s time to shine.
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 end up unraveling if some key conditions are met.
The key element is the cohort of mega-cap tech companies that have long dominated stock market performance, largely due to their connection to AI. BofA says the “everything but bonds” rally has drawn particular attention among the market’s largest stocks, with the top 10 accounting for a record 34% of the S&P 500 market cap, as shown in the chart below.
But BofA doesn’t believe this rapid bull market will last forever. The company outlines a scenario that could derail the rally and ultimately weaken the leadership position of mega-cap growth stocks: Real 10-year yields rise into the 2.5% to 3% range and/or higher yields in Combined with higher credit spreads, this is fueling fears of a recession.
The real 10-year yield is currently at 2.28%, meaning it still needs to rise further before a sell-off eventually occurs in mega-cap names that are heavily weighted in major indices. According to the chart below, it has not exceeded the 2.5 percent mark since October 2023, and even then only for a short time.
Added to this is the consideration that mega-cap technology is no longer moving upwards like an unstoppable monolith. AI-focused Magnificent Seven stocks saw a split as Tesla and Apple got off to a rocky start to 2024, while giants like Nvidia and Microsoft showed no signs of slowing down. Then there’s Meta, which is up more than 40% this year and on track to profitability, but has seen its share price fall significantly because it’s not growing fast enough to keep investors happy.
These divergences have reduced concentration risk in a way that could dampen an eventual sell-off. In the meantime, if you agree with BofA’s view, keep an eye on the 10-year real yield for a signal as to when such a downturn is imminent.
Read the original article on Business Insider