The Stock Market Rally Will Peak in the Next 2 Weeks on Inflation Return

  • The stock market is poised to peak in the next two weeks as inflation makes a comeback, according to Bank of America.
  • The bank said investors should fade the S&P 500 as it approaches the 4,200 level.
  • “Bear risk still disinflation proves ‘transitory’ and/or ‘no landing’ flips to ‘hard landing,” BofA said. 

Investors hoping for a continuation of the stock market rally that began in mid-October are in for a rude awakening, according to Bank of America.

The bank said that the stock market is set to peak in the next two-weeks because inflation is poised to make a comeback.

“We say fade [the] S&P 500 above 4,200,” Bank of America’s Michael Hartnett said in a Friday note. The S&P 500 traded at about 4,170 in Friday trades.

Since the lows of mid-October, the stock market has soared 19% on encouraging data showing that inflation is starting to cool. Even Fed Chairman Jerome Powell acknowledged this fact in his FOMC press conference earlier this week, having mentioned the word “disinflation” 13 times.

But Hartnett thinks the current environment of disinflation could prove transitory, and that will spark the Fed to push on with its hawkish stance and keep raising interest rates. The January jobs report backs up Hartnett’s thinking, as the economy added 517,000 jobs in what continues to be a resilient labor market.

Such a tight labor market could continue to fuel wage increases, which is a contributing factor to the pace of inflation. The one factor that could help spark wage deflation is an increase in immigration to the US and Europe, Hartnett acknowledged.

Hartnett also reminded investors that monetary policy works with a lag, and given the sharp pace of interest rate hikes over the past year, there could be significant pain for the economy in the months ahead. One year ago, the Fed Funds rate stood at 0.25%. Today, the Fed Funds rate is 4.75%. 

The combination of a hawkish Fed and a return to inflation suggests a hard economic landing is still in the cards later this year.

Also of note is the high level of greed currently in markets, according to Hartnett, who pointed to the spread between corporate bond yields relative to treasury bills. The spread is currently at 60 basis points, which is rare.

“Such ‘greed’ preceded tops and crashes,” Hartnett said, noting that years where this spread reached such extremes included 2007, 1973, and 1929. 

But a renewed bull market in stocks is always possible, and Hartnett offered some factors investors should watch for.

“We are bullish bonds [in the] first half of 2023 but once recession starts, yield curve steepens, and only if credit (homebuilders, semis, banks) continues to rally can we be sure bull has begun,” Hartnett concluded.

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