BofA’s Hartnett: Tactical Risk-Off Until Mid-November, Three Conditions to Watch

BofA’s Hartnett: Tactical Risk-Off Until Mid-November, Three Conditions to Watch

TREE NEWS reports: Global investors are pouring money into equities and technology funds at a rapid clip, but Bank of America strategist Michael Hartnett advises maintaining a tactical cautious stance until mid-November. He argues that markets need to digest three major uncertainties: the U.S. midterm elections, turmoil in the French bond market, and risks surrounding AI financing. In the near term, U.S. stocks and the dollar may come under pressure, while the 30-year Treasury yield could drift back toward 5%.

The latest BofA Flow Show report reveals that global equity funds attracted $55.6 billion in the week, with technology funds taking in $18.8 billion—the largest weekly inflow since July. However, the BofA Bull & Bear Indicator fell from 7.4 to 7.2, and consumer and utility funds saw outflows of $2.1 billion and $1.6 billion respectively, both the second-largest single-week outflows on record. Money is still chasing tech, but internal market divergence is widening.

Market Implications

Hartnett’s team maintains a tactical call for “lower bond yields, lower stocks, and a lower dollar,” expecting the dollar index to break below 100 and the 30-year Treasury yield to approach 5%. The key to this outlook lies in whether three risks are absorbed by the market.

• U.S. midterm elections: BofA is watching the possibility of a Democratic sweep. If realized, markets may reassess the sustainability of low-tax, low-regulation policies and the Trump administration’s leadership in AI strategic competition. As the election nears, related expectations could become a major variable for U.S. stocks and the dollar.
• French bond sell-off: The France-Germany 10-year yield spread has widened to 180 basis points, close to the 189 bp high of November 2011. Whether the ECB and the French government can stabilize the bond market will affect the evolution of European sovereign debt risk and could further impact global bond markets.
• AI capex and financing risks: BofA warns that if large cloud companies cut AI capital expenditures or announce large equity offerings, credit spreads could peak. The report flags a break above 200 bp in hyperscaler bond spreads as a key downside risk; currently, the spread is around 130 bp. If financing costs continue to rise, it could trigger deleveraging and transmit stress to shadow banks and broader credit markets.

Short-term risks are not one-sided. If the U.S. announces peace agreements involving Russia-Ukraine and Iran, oil prices could fall by $10-20 per barrel, easing inflation and rate pressure. Conversely, if cloud computing credit spreads widen rapidly, the AI investment boom could morph from a valuation issue into a financing problem.

Three Scenarios for 2027

Looking ahead to 2027, BofA outlines three possible market scenarios: an AI bubble that continues to inflate, a broad rally driven by moderate economic growth, and a deflationary downturn triggered by tightening credit. In the optimistic scenario, the AI industry could extend an expansion trajectory similar to the 19th-century railway revolution, supported by government policies and investors’ habit of buying the dip. Another scenario is a “Goldilocks” economy—continued expansion with easing inflation. Markets generally expect Treasury yields to fall by 40 bp and S&P 500 EPS to grow 15%; if realized, small- and mid-cap stocks trading at around 15x P/E and non-AI S&P 500 components below 20x P/E could see valuation repairs.

But BofA believes market confidence in the first two scenarios may be too high. Its October fund manager survey shows 50% of respondents expect a “no landing,” 40% expect a “soft landing,” and only 6% expect a “hard landing,” indicating relatively insufficient hedging against recession risk.

In the pessimistic scenario, AI investment returns falling short of expectations and tighter financing conditions could force companies to cut capex. BofA notes that hyperscaler capex forecasts for 2027 are as high as $1.2 trillion; if the financing environment deteriorates, investment plans and tech earnings expectations could be hit. Current market forecasts of 4.7% U.S. nominal GDP growth in 2027 and 43% global tech EPS growth also face downgrade risks.

Fund Flows and Market Breadth

Global equity funds saw net inflows of $55.6 billion, with ETFs adding $67.3 billion and mutual funds losing $11.7 billion. Bond funds notched their 78th consecutive week of inflows at $12.1 billion; precious metals funds saw a 16th straight week of inflows at $2.6 billion. Crypto funds attracted just $200 million. By sector, tech funds took in $18.8 billion, the largest weekly inflow since July; energy funds added $1.1 billion, the highest since April. In contrast, U.S. small-cap funds saw outflows of $7.5 billion, and consumer and utility funds also faced large redemptions, showing that investors are not bullish on all equity sectors.

The BofA Bull & Bear Indicator fell from 7.4 to 7.2, reflecting a cooling of market sentiment from the extremely optimistic summer levels. Weakening global equity market breadth, increased hedge fund short positions in oil and S&P 500 futures, and widening high-yield spreads all weighed on the indicator. Meanwhile, a net 30% of global equity indices are below their 50-day and 200-day moving averages, still far from the net 88% required to trigger BofA’s contrarian buy signal. This means that while the risk-reward ratio for some assets may be improving, the market has not yet reached typical extreme oversold levels.

Key Takeaways for Investors

• Hartnett’s short-term call is not that money has fully fled equities, but that markets have not fully priced in policy, sovereign debt, and AI financing risks.
• Until the three conditions show clearer progress, BofA prefers a tactical risk-off stance.
• Whether 2027 brings an AI bubble, a broad rally, or a deflationary recession will depend on whether AI capex translates into profits and whether financing conditions remain stable.
• Investors should watch the dollar index, 30-year Treasury yields, French-German bond spreads, and hyperscaler credit spreads as key indicators.