BofA's Hartnett: Tactical risk-off until mid-November; near-term direction hinges on three conditions

Global capital is accelerating into equities and the technology sector, but BofA strategist Michael Hartnett advises investors to remain tactically cautious until mid-November. He believes the market needs to digest three uncertainties—the U.S. midterm elections, turmoil in the French bond market, and AI financing risks—and that in the near term U.S. stocks and the dollar may come under pressure, while the 30-year Treasury yield is expected to fall back toward 5%.

The latest BofA "Flow Show" report shows that global equity funds attracted $55.6 billion this week, with technology funds taking in $18.8 billion, the highest since July. However, the BofA Bull & Bear Indicator fell from 7.4 to 7.2, and consumer staples and utilities funds saw outflows of $2.1 billion and $1.6 billion respectively, both the second-largest single-week outflows on record. Money is still chasing tech stocks, but divergence within the market is widening.

The BofA strategy team will maintain its tactical call of "bond yields down, stocks down, dollar down," expecting the dollar index to fall below 100 and the 30-year Treasury yield to move toward 5%. Whether this call materializes hinges on whether the market can digest three risks.

Three conditions determine the near-term market direction

First, the policy risk of the U.S. midterm elections needs to be fully priced in. BofA is watching the possibility of a Democratic sweep of Congress. If that scenario materializes, the market may reassess whether the low-tax, light-regulation policy environment can continue, as well as the Trump administration's leadership in the AI strategic competition. As the election approaches, related expectations could become an important variable affecting U.S. stocks and the dollar.

Second, Europe needs to contain selling pressure on French government bonds. The BofA report notes that the spread between French and German 10-year government bonds has risen to 180 basis points, close to the November 2011 high of 189 basis points. Whether the European Central Bank and the French government can stabilize the bond market will affect the evolution of European sovereign debt risk and could further hit global bond markets.

Third, AI capital expenditure and financing risks need to reach a turning point. BofA warns that if large cloud computing companies cut AI capital expenditure or announce large-scale equity offerings, the credit spreads of the companies involved may peak. The report lists a widening of hyperscaler bond spreads beyond 200 basis points as a key downside risk; the spread is currently about 130 basis points. If financing costs continue to rise, it could trigger investor deleveraging and transmit pressure to shadow banking and the broader credit market.

Near-term risks are not one-directional. If the United States announces peace agreements on Russia-Ukraine and Iran, oil prices could fall by $10 to $20 per barrel, easing inflation and interest rate pressure; conversely, if cloud computing companies' credit spreads widen rapidly, the AI investment boom could evolve from a valuation problem into a financing problem.

Three scenarios for 2027: AI bubble, broad rally, and deflationary recession

Looking ahead to 2027, BofA lays out three possible market scenarios: the AI bubble continues to inflate, moderate economic growth drives a broad market rally, and tightening credit triggers a deflationary downturn.

In the optimistic scenario, the AI industry could extend an expansion trajectory similar to the 19th-century railway revolution, with government policy support and investors' habit of buying the dip also supporting the market. Another scenario is a "Goldilocks" economy, in which growth continues and inflation pressure eases. The market widely expects Treasury yields to fall by 40 basis points and S&P 500 earnings per share to grow 15%; if this scenario materializes, small-cap and mid-cap stocks trading at about 15 times earnings, as well as S&P 500 non-AI constituents trading below 20 times earnings, could see valuation repair.

But BofA believes the market may be overconfident in the first two scenarios. Its October fund manager survey shows that 50% of respondents expect a "no landing," 40% expect a "soft landing," and only 6% expect a "hard landing," reflecting relatively insufficient investor protection against recession risk.

In the pessimistic scenario, AI investment returns falling short of expectations and tighter financing conditions could force companies to cut capital expenditure. BofA notes that hyperscaler capital expenditure is forecast at up to $1.2 trillion in 2027; once the financing environment deteriorates, the investment plans of the companies involved and tech stock earnings expectations could both be hit. The market's current forecasts of 4.7% U.S. nominal GDP growth in 2027 and 43% global tech sector EPS growth also face downgrade risk.

Money is still flowing in, but divergence is emerging within the market

Global equity funds saw net inflows of $55.6 billion this week, of which ETFs took in $67.3 billion and mutual funds saw outflows of $11.7 billion; bond funds recorded net inflows for a 78th consecutive week, totaling $12.1 billion; precious metals funds saw net inflows for a 16th consecutive week, totaling $2.6 billion. Cryptocurrency funds took in only $200 million.

By sector, technology funds took in $18.8 billion, the largest weekly inflow since July; energy funds took in $1.1 billion, the highest since April. In contrast, U.S. small-cap funds saw outflows of $7.5 billion, and consumer staples and utilities funds also saw large redemptions, indicating that money is not broadly bullish on all equity sectors.

The BofA Bull & Bear Indicator fell from 7.4 to 7.2, reflecting that market sentiment has cooled from the extremely optimistic levels of the summer. Weakening breadth in global equity markets, hedge funds adding short positions in oil and S&P 500 futures, and widening high-yield bond spreads all weighed on the indicator.

At the same time, a net 30% of global equity indices are below their 50-day and 200-day moving averages, still well short of the net 88% needed to trigger BofA's contrarian buy signal. This means that although the risk-reward ratio of some assets may improve, the market has not yet reached a typical extreme oversold level.

Overall, Hartnett's near-term view is not that capital has fully fled equities, but that the market has not yet fully digested policy, sovereign debt, and AI financing risks. Until the three conditions show clearer progress, BofA prefers to maintain a tactical risk-off stance; whether the market in 2027 heads toward a continued AI bubble, a broad rally, or a deflationary recession will depend on whether AI capital expenditure can translate into profits and whether the financing environment can remain stable. Risk disclosure and disclaimer

Markets carry risk, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Investment based on this is at the user's own risk.