Instead of buying the market dip, investors should be selling the rips in the stock market as the Federal Reserve begins to raise interest rates into a bear market, Bank of America (BofA) said in am investor note published on Friday.
“We believe [the] bull era of central bank excess, Wall Street inflation, [and] globalization [is] ending, and [a] bear era of government intervention, social and political polarization, Main Street inflation, and geopolitical isolationism [is] starting,” Bank of America Michael Hartnett said.
While the major stock market indexes are technically not in a bear market, BofA notes that most individual stocks are already in one. According to the note, 76% of Nasdaq stocks and 51% of S&P 500 stocks are at least 20% off their 52-week highs.
In fact, the Nasdaq 100 briefly entered bear market territory on Thursday, falling more than 20% from its record high before it staged a sharp reversal as investors digested the implications of Russia’s attack against Ukraine.
This market weakness has spread to different stock market sectors that are pointing to a potential recession ahead. This is especially true for the housing stocks. Two of the largest companies in this sector, Home Depot is down 29% from its recent peak, and homebuilder Toll Brothers is down 38%.
“[This] rarely happens outside of recession,” BofA warned, continuing that “the consumer is always right.”
Something that is fueling the deterioration in the stock market are the expectations that the Fed will begin to raise interest rates and reduce its balance sheet just as the economy starts to slow down and a bear market unfolds.
“‘Inflation shock’ means ‘rates shock’ which means ‘growth shock’ = negative returns in credit and stocks in 2022,” BofA said.
Russian invasion of Ukraine only exacerbates the bearish fundamentals as the war could very well lead to continued commodity price inflation and a policy mistake by the Fed.
In the end, BofA sees significant downside in the S&P 500 before a “Fed put” would be activated. The “Fed put” is code word for how low the S&P 500 needs to decline before the Fed will step in and make a dovish policy pivot in order to stop the decline.
The bad news for the bullish investors is that, according to BofA, the “Fed put” won’t hit until the S&P 500 falls below 3800, representing a potential downside of at least 12% from the current price levels.