- The stock market is undergoing a final melt-up that will culminate in a top sometime between election day and the inauguration, according to Michael Hartnett, the chief investment strategist at Bank of America.
- He says investors are front-running good news including fiscal stimulus and a vaccine, both of which could come by early next year.
- He further pinpoints how the rally will be short-circuited once these catalysts are out of the way and the top is reached.
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3,600. That’s the level on the S&P 500 that will eventually serve as the high-water mark for the ongoing rally in stocks, according to Bank of America Chief Investment Strategist Michael Hartnett.
That level would be a record high for the S&P 500, and it is 4% above Friday’s levels. However, before you take that cheery aspect of Hartnett’s forecast and run with it, consider why he definitively calls it the “top.”
The 3,600 level on Hartnett’s radar is the upper end of a 3,300-3,600 band he had expected the S&P 500 to trade in between August and January 2021. And so far, his forecast is playing out.
To understand why he’s expecting a top in stocks, it’s worth walking through the reasons he highlights for why the market will continue ascending in its “final melt-up.”
He anticipates that during the fourth quarter, investors will preemptively price in the successful passage of additional fiscal stimulus for the pandemic-stricken economy. Indeed, this singular event has recently been a key driver of the market’s daily swings, and it boosted stocks on Friday after the White House signaled its interest in passing a bigger stimulus package.
Hartnett also expects that investors will front-run a COVID-19 vaccine — another variable that so much of the future outlook is hinged upon. A survey Bank of America conducted in September showed that the plurality of fund managers expect a successful vaccine to be announced early in the first quarter of 2021.
Last — and certainly not least — the final melt up will be driven by a Federal Reserve that is supporting the market in an unprecedented manner. Its monetary support, combined with the fiscal dose, has yielded $21 trillion in stimulus this year. Hartnett says this amount represents a peak in easy financial conditions, as stimulus of this magnitude will simply not be repeated next year.
While the central bank’s end goal is to reduce unemployment, other outcomes include higher asset prices and, potentially, an asset bubble, he added.
The question now is, what happens when stocks reach the cliff’s edge, which Hartnett pinpoints at 3,600 for the S&P 500? Look no further than the bond market.
At some point, higher stock prices will give rise to a sell-off in Treasuries that pushes yields higher and short-circuits the rally, he says.
The relationship between both asset classes has been unusual this year. While they typically move in opposite directions, stocks and bonds fell together during the March crash. And during the near-10% drop in September, the 10-year yield barely budged higher.
Hartnett is now flagging that this relationship could return to normal, and higher yields would dent the valuations that investors have assigned to stocks. He notes that long-term interest rates are already on the rise ahead of the election, with the 30-year yield climbing last week to its highest level since June.
“We believe the top in asset prices comes between election & inauguration, as fiscal, vaccine, recovery fully priced-in with SPX>3600, and bond yields on the rise,” Hartnett concluded.
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