Inside BofA’s Negative 2022 Stock Market Outlook

By the Curmudgeon




BofA Chief Investment Strategist Michael Hartnett maintains his view of negative U.S. stock market returns this year, driven by an interest rates shock.  Let’s explore that thesis, look at historical stock market declines during midterm election years, and hint at possible surprises from this week’s FOMC meeting.


BofA’s 2022 Equity Market Outlook:


In-line with BofA’s Economics team, Michael agrees the Fed is well behind the curve in hiking interest rates. In addition, leading indicators for corporate profits, like the NY Empire Manufacturing Survey (highly correlated to the S&P 500 as per graph below), are starting to head south. Michael thinks the combination of rates up and profits down is bad for credit and stocks.


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Source: BofA Global Investment Strategy, Bloomberg



Hartnett believes "interest rates shock" is just beginning and

rate expectations are too low.  He notes that stocks, credit, and housing markets have been conditioned for an indefinite continuation of the "Lowest Rates in 5000 Years.” So, it might only take a couple of Fed rate hikes to cause an “event” (see Conclusions below).


Michael notes investors aren’t short just yet with $52B of inflows into stocks 2022 YTD. He recommends being long volatility, high quality, and defensive stocks on tighter financial conditions. 


BofA U.S. Equity & Quantitative Strategist Savita Subramanian agrees that some of the bearish themes for equities that the bank worried about in 2021, such as tighter monetary policy and margin pressures from labor, are now playing out.  Here’s an interesting historical drawdown table for your consideration:


Table 1:  3-month S&P 500 drawdowns in midterm election years


Midterm year Peak to Trough Drawdown

1930 Apr-30 Jun-30                                 -25%

1934 Feb-34 May-34                               -20%

1938 Jan-38 Mar-38                              -29%

1942 Jan-42 Mar-42                              -12%

1946 May-46 Sep-46                             -20%

1950 Jun-50 Jul-50                                -14%

1954 Aug-54 Aug-54                               -4%

1958 Feb-58 Feb-58                                -4%

1962 Mar-62 May-62                            -22%

1966 Jul-66 Oct-66                               -16%

1970 Apr-70 May-70                            -23%

1974 Aug-74 Oct-74                             -25%

1978 Sep-78 Nov-78                            -14%

1982 May-82 Aug-82                           -14%

1986 Sep-86 Sep-86                               -9%

1990 Jul-90 Oct-90                               -20%

1994 Feb-94 Apr-94                               -9%

1998 Jul-98 Aug-98                              -19%

2002 May-02 Jul-02                             -28%

2006 May-06 Jun-06                              -8%

2010 Apr-10 Jul-10                              -16%

2014 Sep-14 Oct-14                               -7%

2018 Sep-18 Dec-18                             -20%

Average drawdown=                             -16%


Source: BofA Global Investment Strategy, Bloomberg



Curmudgeon Comments:


BofA’s Hartnett writes that the Fed will be raising rates in highly overvalued credit and equity markets.  He adds that Fed tightening always "breaks" something.  


What could that “something” be this time around – stock, bonds, real estate, art, cryptos, take your pick?


One possible surprise at this week’s FOMC meeting would be for the Fed to further accelerate the tapering of its bond purchases, winding them up by mid-February, a month earlier than currently scheduled, wrote Nomura economists Aichi Amemiya, Robert Dent, and Kenny Lee in note to clients. That would represent a marginal reduction of $20 billion in Treasury and $10 billion in agency mortgage-backed securities acquisitions but would send a signal to the market about the Fed’s anti-inflation resolve.


The U.S. central bank continues to buy $40 billion of Treasuries and $20 billion in MBS per month, adding to its near-$9-trillion balance sheet.  That means that it is easing, rather than tightening, monetary policy, while “talking” of the need to curb inflation. 


Fed “talking the talk” is why Victor believes there will be only two rate hikes this year.


Economists Cynthia Wu of Notre Dame and Fan Dora Xia of the Bank for International Settlements have estimated a “shadow fed-funds rate,” which is based on its asset purchases and tracked by the Atlanta Fed. The Wu-Xia shadow funds rate was minus 1.15% as of Dec. 31st, according to the Atlanta Fed.


Ryding says Wu estimates that a change in the Fed’s balance sheet equal to 10% of U.S. gross domestic product—about $2 trillion—is roughly equivalent to a 100-basis point change in the fed-funds rate.

As for the Fed beginning to normalize its balance sheet, the Nomura economists think the announcement could come as early as the March or May FOMC meeting. Most Fed watchers expect a later start to the process of reducing the central bank’s securities holdings, after two or more rate hikes. And almost all think the Fed will allow maturing issues to run off at a predictable pace, rather than sell securities outright.




Nowhere is the impact of Fed monetary policy more apparent than in elevated asset prices – from the doubling of the S&P 500 since its March 2020 bottom to home prices jumping over 20%.


The end of the pandemic means the end of excess stimulus, which likely spells the end of excess asset returns.  Check the recent charts of Zoom, Peloton and Netflix, among other highfliers for evidence.


Investors will be listening carefully to what Powell and his cohorts say at the FOMC meeting this week (and beyond) about ending QE (for now), normalizing rates (“neutral is the new tightening”), and reducing its balance sheet (which Modern Monetary Theorists says can grow to infinity?).


Closing Cartoon:



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Stay healthy, enjoy life, success, good luck and all the best for 2022.  Till next time.…

The Curmudgeon

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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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