Active Defense! Bank of America: The current market shows characteristics of a late-stage bubble

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The global financial markets are at the intersection of extreme bullish sentiment and a shift in macro trends, marking the start of structural rotation in asset prices. According to the Chase Wind Trading Desk, a recent report from Bank of America Global Research shows that the current market displays typical late-stage bubble characteristics and suggests investors should step back from the blind frenzy over artificial intelligence and adopt more proactive defensive investment strategies.

Latest data shows Bank of America's core contrarian "Bull & Bear Indicator" has dropped to 9.4, but remains deeply in the "extreme bullish" range, meaning the "sell risk assets" signal that started mid-December last year is still valid. Although as much as $46.3 billion poured into global equities in just one week, increasing market divergence is emerging, with early signs of capital shifting from "AI worship" to "AI scarcity."

This rotation is directly reflected in asset price performance. Iconic assets of Wall Street’s wealth boom are showing signs of fatigue—hot assets like the Magnificent 7 tech giants and Bitcoin are trailing the broader market, while assets benefiting from real economy recovery like silver, regional banks, and industrial metals are performing strongly. Bank of America warns that any announcement by AI cloud giants to cut capital expenditures would be the most direct catalyst for a complete reversal of this trend.

Facing a complex and rapidly changing market environment and valuation pressures, Bank of America strategist Michael Hartnett recommends investors take a more defensive and forward-looking asset allocation approach in 2026. The report notes that long-duration U.S. Treasuries are presently the best risk hedging tool, and in the long term, emerging markets and small-cap value stocks will take over from large tech stocks to lead the next long-term bull market.

Sentiment indicator signals extreme greed, tech bubble faces capital expenditure test

Despite continued inflows into global equities, Bank of America’s liquidity indicators signal subtle changes in the market.

Bank of America’s private banking clients posted the largest net outflow of cash and intermediate-term Treasuries in the first week of February in the past 14 years, with funds shifting into municipal bonds, investment-grade bonds, and Japanese equity ETFs. However, beneath the surface exuberance, the tech stock bubble is facing a harsh fundamental test.

The report states that India’s tech sector was the first to be impacted by the AI shock in Q1. The costs fueling the AI arms race are rising sharply; over the past five months, large cloud providers (hyperscalers) have issued $170 billion in bonds—far above the annual average of $30 billion between 2020 and 2024—and their credit spreads are widening.

Michael Hartnett stresses that overcrowded trades often lose steam during position adjustments; if mega-cap tech companies announce capital spending cuts, tech stocks face serious valuation adjustment risks.

Capital rotates faster, long bonds become best risk hedge

In the fixed income market, capital has flowed into bonds for 42 consecutive weeks, with $25.4 billion accumulated so far this year. As equity valuations remain high, the defensive properties of bonds are back in focus.

Year-to-date, zero-coupon Treasuries (ZROZ) are up 4%, while the Nasdaq 100 Index is down 2%. Bank of America analysis believes that if declines in large financial stocks cause credit spreads to widen overall, bonds—especially long-term Treasuries—will be the most reliable risk hedging tool for 2026.

At the macro policy level, the Fed’s rate-cut cycle may have ended, meaning the curve-steepening trade is nearing completion. With the U.S. government needing to tackle housing and living costs affordability in the election year, and AI’s deflationary effects accelerating, Treasury yields have downward pressure.

Despite U.S. national debt ballooning by $1 trillion every 100 days and "buy everything but bonds" remaining the decade’s investment theme, during the inflation lull of 2025–2026, going long government bonds remains Bank of America's top defensive exposure.

Macro trend shift: large-cap growth gives way to small-cap value

The past 50 years show that major political, geopolitical, and financial events always trigger shifts in asset market leadership.

Currently, U.S. policy is increasingly focused on the real economy and living costs, profoundly impacting asset performance ahead. Since the Fed’s rate cuts and policy shift, market winners are mainly real economy inflation-exposed assets like silver, the Korea KOSPI index, materials and energy sectors; meanwhile, Wall Street wealth-exposed assets lag behind.

Bank of America points out that capital markets are undergoing a major long-term turning point. As economic focus shifts from services to manufacturing, small-cap stocks in the real economy will outpace large-cap stocks on Wall Street. Capital flows confirm this: recently, U.S. small-cap stocks saw the largest weekly inflow in eight weeks.

"Anything but dollar" trades emerge, emerging markets to lead long-term bull

Under the global realignment, "American exceptionalism" is shifting toward global rebalancing.

The U.S. government’s overheated economic policy is creating a new "anything but dollar" (ABD) trade trend. Bank of America predicts the next long-term bull market will be led by international stocks, especially emerging markets. The logic: AI development consumes vast commodities, and emerging markets are major commodity producers.

Data-wise, Korea’s stock market just hit a record four-week net inflow ($14.3 billion) since 2002.

Meanwhile, the price correlation between the yen and Nikkei index turned positive for the first time since 2005. This “currency and equity rising together” is a classic hallmark of a long-term bull market. But Bank of America also warns that in the near term, the yen must not surge disorderly (e.g., drop below 145); otherwise, global liquidity and global deleveraging risks will be triggered.

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The wonderful content above is from Chase Wind Trading Desk.

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Risk Warning and DisclaimerThe market involves risks, and investment requires caution. This article does not constitute personal investment advice nor considers any specific user's investment goals, financial situation, or needs. Users should consider whether any opinions, viewpoints, or conclusions herein fit their particular situation. Investing based on this article is at one’s own risk. ```