Macro

BofA’s Hartnett Warns 71% of Equity Indexes Nearing Sell Signal

Nvidia earnings report on Wednesday could be a significant market-moving event amid high interest rates and geopolitical instability.

By Barry Stearns

5/24, 05:09 EDT
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Key Takeaway

  • Bank of America's Michael Hartnett warns that 71% of equity indexes trading above their 50- and 200-day moving averages signals potential market overheating.
  • The MSCI All-Country World Index, after hitting record highs, is now facing its first weekly decline in five weeks due to strong economic data.
  • Global equity funds saw $10.5 billion in inflows through May 22, indicating continued investor interest despite market caution.

Market Volatility Concerns

The U.S. stock market is currently navigating a complex landscape marked by persistently high interest rates, political uncertainty, and geopolitical instability. These factors are contributing to a cautious sentiment among investors, especially as the market trades at premium valuations. The upcoming earnings report from Nvidia, scheduled for Wednesday, is anticipated to be a significant market-moving event. According to Goldman Sachs strategists, the bank's measure of risk appetite hit its highest level since 2021 last week, driven by optimism around economic growth and monetary policy. However, momentum has slowed, and there is a noticeable increase in demand for hedges against sudden market declines, as indicated by CBOE Volatility Index (VIX) options data. "This suggests markets are pricing less risk of a sustained drawdown from here, but are worried about temporary spikes in volatility," said Andrea Ferrario, a strategist at Goldman Sachs.

S&P 500 Technical Analysis

The S&P 500 has recently broken out above its 2021 highs of 4,820, raising questions about whether this level will now act as support. Historical market behavior suggests that a retest of this level is possible, especially considering the mid-2023 decline of about 11%. An equal distance decline from current levels projects a move to 4,725. Additionally, the uptrend support line indicates significant support in the 4,820-4,700 zone. Todd Gordon, founder of Inside Edge Capital, expressed uncertainty about whether this support will hold. "If we test that zone and we don’t hold support, then I am concerned," he said. To hedge against this potential downside, Gordon suggests using an option spread strategy involving the S&P 500 (SPX) September 20 put options. This strategy involves buying the 5,000 strike put and selling the 4,500 strike put, costing $29.50 per spread. If the S&P 500 drops to 4,500 by September 20, the max profit on this spread would be $47,050, offering a potential hedge against a 15% drawdown in a $1,000,000 portfolio.

Investor Sentiment and Positioning

Investor sentiment is currently mixed, with some market participants optimistic about economic data allowing the Federal Reserve to cut interest rates later this year. Data from Citigroup Inc. showed a rise in bullish positioning levels in S&P 500 and Nasdaq 100 contracts last week. However, the market is "almost exclusively one-sided," according to Citigroup strategist Chris Montagu, who noted that "profit levels are only beginning to develop, which limits positioning risks." Wall Street strategists are also becoming more optimistic, with Morgan Stanley’s Michael Wilson, a prominent bear on U.S. stocks, recently capitulating his pessimistic view. JPMorgan Chase & Co.’s Marko Kolanovic remains one of the few bearish voices on equities.

Street Views

  • Michael Hartnett, Bank of America (Neutral on global equity markets):

    "The rally in global equity markets is at risk of overheating... About 71% of equity indexes are trading above both their 50- and 200-day moving averages. A reading above 88% would trigger a contrarian sell signal."

  • Barclays Plc Strategists (Neutral on the stock market rally):

    "The rally was starting to look tired. Stretched positioning and seasonal trends could keep stocks treading water as the corporate earnings season winds up."