Fed Pivot Sends Shockwaves Through Bullish Stock Market: BofA

The Federal Reserve's hawkish pivot this week has abruptly shifted investor sentiment, causing a surge in volatility and raising concerns about the sustainability of the recent stock market rally, reports Bloomberg.

"Risk appetite has suddenly turned twitchy," states Bank of America Corp. strategist Michael Hartnett, in a note cited by Bloomberg. The S&P 500 is on track for its worst weekly performance in over three months, as the Fed's shift towards a less accommodative stance on interest rate cuts has dampened earlier expectations.

This shift comes at a time when investor confidence had been at an all-time high. BofA's monthly fund manager survey, released earlier this week, revealed record allocations to US equities and near record-low cash holdings, signaling an extremely bullish sentiment.

In his note, Hartnett highlights the S&P 500 Equal Weighted Index's sharp decline of over 7% since November's record highs, contrasting with the S&P 500's relatively smaller decline of under 3% in the same period. This divergence indicates that a small number of top-performing stocks are currently propping up the broader market.

Hartnett warns that the SPDR S&P Bank ETF needs to remain near its 2022 highs to prevent further erosion of investor confidence. Earlier this year, he advised investors to diversify out of US stocks and into regions like China and Europe ahead of President-elect Donald Trump's inauguration in January.

Despite the current turbulence, 2024 is shaping up to be a record year for US equity inflows, according to BofA. This follows a similarly strong 2023, with the S&P 500 rallying over 23% throughout the year.

This year's rally was largely driven by optimism surrounding a resilient US economy, advancements in artificial intelligence, and falling interest rates. However, the Fed's less dovish tone this week has raised questions about the longevity of this bull market.

While bond funds saw their first outflows in over a year, at $6 billion, this week saw record inflows into global equity funds, at almost $69 billion, and US stock funds, at $82 billion, according to EPFR Global data cited by BofA.

Hartnett also notes that "abnormally large daily inflows across all S&P 500 funds this Wednesday, possibly related to upcoming Dec. 23 quarterly rebalance." This rebalancing coincides with Friday's quarterly "triple-witching," which involves the expiration of $6.5 trillion in options tied to individual stocks, indexes, and ETFs.