Bank of America Hartnett: Contrarian investors are waiting for two signals, ready to switch to a risk-averse mode.

Bank of America's chief investment officer, Michael Hartnett, warned that despite the current extremely bullish market sentiment, contrarian investors are preparing for a sudden shift in market sentiment and are ready to switch their portfolios to a "risk-averse" mode at any time .

In his latest Flow Show report, Hartnett argues that the core of this potential shift lies in two key upcoming signals: a potential compromise in the US-Iran conflict and the upcoming US midterm elections . Any sudden de-escalation of geopolitical tensions or an unexpected shift in political power could quickly shatter the fragile consensus currently supporting the leaderless rally in risk assets.

The report points out that market funds have begun to hedge against the risk of fiat currency devaluation, and safe-haven assets are experiencing a large influx of funds. Latest data shows that gold and cryptocurrencies attracted over $10 billion in a single week, while the US stock market experienced significant outflows , highlighting the underlying capital flows and investor defensiveness beneath the surface of apparent prosperity.

Meanwhile, the bond market is vying for dominance in global asset pricing. Hartnett believes that whether policymakers can successfully suppress long-term government bond yields is not only crucial to the financing environment for AI capital expenditures, but also the absolute key to whether the current risk appetite in the stock market can be sustained.

Two major reversal signals: the waiting list for contrarian investors

In its report, Hartnett clearly outlined two major "reversal risk" opportunities that contrarian investors are waiting for:

First, a de-escalation of US-Iran tensions and a final drop in oil prices. If the conflict between the US and Iran substantively eases, oil prices will face one last round of downward pressure. At that time, market optimism regarding EPS expectations may have peaked, providing an entry window for shorting risky assets.

Second, the results of the US midterm elections. Hartnett explicitly pointed out that if the Republicans lose a Senate seat or the governorship of Texas, it will have a negative impact on the market . His logic is as follows:

Voters are demonstrating through their votes that affordability and controlling inflation are political priorities over tax cuts, deregulation, or boosting stock prices, which will fundamentally shake the policy foundation of current market consensus.

Before the two signals mentioned above are triggered, Hartnett believes that the market will continue its "grinding" pattern without a leading sector, while contrarian investors should remain highly vigilant and be ready to switch to risk-averse mode at any time.

Fund flows and sentiment indicators: Safe-haven assets see a buying frenzy

Amid recent market volatility, capital flows have exhibited a strong "anti-devaluation" characteristic.

According to a report by Bank of America, funds are being withdrawn on a large scale from traditional risky assets and are flowing into alternative safe-haven assets.

Specifically, gold saw a $7.3 billion in inflow, while cryptocurrencies saw a $3.2 billion in inflow, both the largest inflows in 25 years since October .

In stark contrast, U.S. stocks saw a $4.4 billion outflow, the first in five weeks; high-yield bonds also recorded a $700 million outflow . Although the technology and materials sectors still saw inflows, the overall liquidity situation showed a defensive bias.

In addition, the Bank of America Bull & Bear Indicator climbed further to 9.7 last week, essentially hitting an all-time high .

Harnett believes this extremely bullish indicator is primarily driven by increased global stock index breadth and hedge funds increasing their long positions in gold and short positions in the VIX. Although the S&P 500 has risen slightly after triggering a "sell signal" on May 26, the extreme positioning has created a potential risk of a pullback.

Bond pricing power: Yield becomes the core point of market competition

In his report, Michael Hartnett bluntly stated that the current situation is "bond trading information, stock trading philosophy." Amid the AI investment boom, AI bonds are seen as a leading indicator.

The report points out that the underperformance of AI spenders (MAGS) and AI builders (SOX) relative to AI adopters will only end when the 30-year Treasury yield falls below 5% , but this goal seems unlikely to be achieved in the short term.

Hartnett believes that Federal Reserve Chairman Warsh's speech at Jackson Hole attempted to balance inflation with the yield curve. Although the 2-year and 30-year yield curve flattened significantly after the speech and the dollar rebounded, broader risk appetite did not recover as expected, and Treasury yields even broke through the key intervention level of 4.7% .

Michael Hartnett believes that the policy combination of Bessant and Warsh must prevent U.S. Treasury yields from rising further, or long-duration trades will face enormous pressure.

Policy and Positioning: The Clash Between the Central Bank's Shift and the Consensus on a "No Landing" Policy

From a market positioning perspective, investors are currently basking in a perfect consensus: no macroeconomic landing, no Fed rate hikes, no cuts to AI capital expenditures, and no Democratic sweep. Asset allocation exhibits characteristics of being long on stocks, long on investment-grade bonds, and short on government bonds and the US dollar.

However, to hedge against the risk of such a high degree of consensus, Michael Hartnett persists in going long on commodities such as gold and global natural resources .

At the policy level, central banks around the world are quietly changing course. The report points out that in the past three months, central banks worldwide have raised interest rates 13 times, exceeding the 12 rate cuts. Bank of America predicts that by the end of the year, there will be a situation of 17 rate hikes versus 4 rate cuts .

Hartnett believes that the central bank's interest rate hikes will help coordinate with the US Treasury's bond and foreign exchange interventions to suppress long-term yields—crucial for financing the AI capital expenditure boom and preventing consumers from increasing precautionary savings due to concerns about the $40 trillion in national debt. It's worth noting that the US Treasury's bond repurchase program will end on November 4th, exactly one day after the US midterm elections.

On the political front, Trump’s approval ratings for the economy (35%) and inflation (28%) have both declined again.

Hartnett points out that a quick end to the US-Iran conflict is the easiest way to boost approval ratings , which is also the core logic behind contrarian investors' close attention to the situation in Iran.

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