U.S. stock market bear signal triggered at 70%! Bank of America advises taking profits

Wall Street is showing clear divisions after the sharp drop in U.S. tech stocks. Bank of America issued a warning, stating the market has "too many danger signals," advising investors to take profits; meanwhile, institutions such as Morgan Stanley and Citi remain bullish, suggesting buying on the dip.

Last Friday, the Philadelphia Semiconductor Index plunged more than 10% in a single day, the largest one-day decline since March 2020, and the fourth largest since the index began recording data in 1994. Strong U.S. employment data pushed up bond yields, increasing bets that the Fed's next move will be to raise rates, further suppressing risk sentiment.

Savita Subramanian, head of quantitative strategy at Bank of America, promptly released a report, stating "too many danger signals, take profits," maintaining the S&P 500 year-end target price at 7100 points, implying about 6% downside from last Friday's closing price.

Despite this, Morgan Stanley strategist Mike Wilson still insists the S&P 500 will reach 8000 points by year-end, and Citi strategist Scott Chronert's team raised their year-end target from 7700 to 8100 points. Both institutions cite strong corporate earnings growth and robust macro data as their main arguments.

The two diametrically opposing views have left investors facing a dilemma after the tech stock sell-off: whether to take advantage of the dip to build positions or lock in profits before further market turbulence.

Bank of America: Bear market signals triggered at 70%, reaching historic peak

The core basis for BofA's warning is its quantitative signal system tracking bear market precursors. According to Subramanian's report, seven out of ten indicators BofA monitors have now been triggered—two added in May, five in April, four in March—bringing the trigger ratio to 70%, matching the average level seen before the S&P 500's seven market peaks since 1990.

The two most recently triggered signals are particularly noteworthy: first, high P/E stocks have significantly outperformed low P/E stocks, viewed as a classic sign of excessive speculation; second, long-term growth expectations are too high, and valuation levels are in sensitive territory where stocks are more susceptible to disappointment on earnings.

BofA's sentiment model "Sell Side Indicator" has not been formally triggered yet, but saw clear deterioration in May, with market sentiment becoming extremely optimistic. Meanwhile, the yield curve has not inverted, but the spread between 2-year and 10-year Treasury yields has compressed to 39 basis points, the lowest since reciprocal tariffs.

The report also notes that even purely from a valuation perspective, 17 of BofA's 20 tracked metrics for the S&P 500 are above historical averages, also showing overall index overvaluation risks.

Tech sector eerily resembles the February 2000 internet bubble peak

BofA's most striking assertion in its warning is the direct comparison of the current tech sector's trajectory to February 2000—roughly one month before the internet bubble peaked.

The key indicator cited is sector internal divergence: the median performance gap between the best and worst quintile stocks in the tech sector is now around 120 percentage points, the highest since February 2000—back then this metric reached about 130 percentage points just before the market peak on March 24, 2000.

From individual stock gains, the median stock in today's best-performing tech quintile has risen about 110% in the past three months; during the internet bubble, similar stocks’ peak gains before the bust were also around 120%.

BofA concludes that the current situation and February 2000 have three significant similarities:

The energy sector ranks first in BofA's tactical sector model, combining momentum, earnings revisions, and valuation advantages; Information Technology and Communication Services tie for second, with strong momentum and earnings revisions but high valuations; Consumer Staples ranks last, mirroring February 2000—that sector proved most resilient after the tech bubble burst, outperforming the index by 73 percentage points during the S&P 500's trough from March 2000 to October 2002.

Morgan Stanley and Citi remain bullish: Earnings revision breadth at new cycle high

Regarding the same market volatility, Morgan Stanley's Mike Wilson reached a diametrically different conclusion. In his Monday report, he noted that the S&P 500’s rapid rise since the March lows was unlikely to last, and this adjustment is "inevitable and ultimately beneficial for the bull market to continue to year-end."

Wilson's bullish rationale centers on earnings revision breadth: the S&P 500’s earnings revision breadth now stands at 26%, a new high for this cycle.

On the macro side, ISM Manufacturing PMI rose to 54 last week, its highest since 2022; private sector payroll growth three-month average improved to 166,000, strongest since 2023. He believes after the normalization of crowded semiconductor and storage stock positions, cyclical sectors such as consumer discretionary, transportation, and regional banks are poised to lead gains.

Citi's Scott Chronert raised the S&P 500 year-end target from 7700 to 8100 points due to "significant jump in earnings expectations," implying 9.7% upside from last Friday's close.

BofA acknowledges tech fundamentals are stronger than during the internet bubble, but signs of deterioration emerge

BofA did not outright deny the current tech sector’s fundamentals. The report notes that on leverage, valuations, and capital intensity, the health of today’s tech sector is better than during the internet bubble.

However, the report lists several signs of deterioration emerging since the start of the year: free cash flow conversion has plateaued, supply of investment-grade bonds and stocks has increased, and the proportion of buybacks to market cap has slowed; the ratio of capex to operating cash flow for large-scale cloud companies is expected to reach nearly 100% by year-end, up sharply from 40% in 2023. Although this is still below the telecom sector peak of 140% in 2001, the pace of increase has raised concerns.

Subramanian writes in the report that the S&P 500 has risen about 11% this year, but overall gains are mainly driven by earnings revisions, and the forward P/E has actually compressed slightly from 22x at the start of the year to 21x.

Meanwhile, sectors such as financials, healthcare, and consumer discretionary have recorded negative returns this year, and index-level strength masks the fact that internal return dispersion has risen to its highest since the pandemic.

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