Bank of America knows what it’ll take to send the market into a ‘full bull detox’ — and we’re dangerously close – Business Insider

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  • Bank of America Merrill Lynch has identified a handful of market drivers it thinks are signaling a “full bull detox.”
  • Conditions still need to shift further before it’s a real threat, but BAML pinpoints exactly what investors should be watching in preparation.

Michael Hartnett realizes you’re worrying about a trade war, and he has some advice for you: Keep an eye on the bigger and potentially more catastrophic issue at hand — the Federal Reserve‘s ongoing monetary tightening.

It’s this removal of accommodation that Hartnett thinks will ultimately send the market into what he calls a “full bull detox,” or a reversal of the risk-seeking behavior that has characterized it for so long.

While the so-called detox is still in its nascent stages, Hartnett says traders would be wise to keep an eye on three dynamics that will signal its progression:

  1. Investors will slowly rotate from QE winners to QE losers— That means going from the likes of tech/US stocks and biotech to equity volatility, commodities, and the US dollar, BAML says.
  2. Peak positioning, peak profits, and peak policy stimulus— This would signal it’s time to consider a “sell the rip” strategy that serves as the inverse of the “buy the dip” trade that has been so crucial for the US stock market’s nine-year bull market run.
  3. The theme of the second quarter will shift from volatility to more rotation-based trading— BAML says this means a wide trading range and a specific rotation from cyclical plays into defensive ones.

But not so fast, Hartnett says. For the bull detox to truly take hold, credit spreads will have to widen significantly, which could in turn signal a “decisive crack” in equities, he argues. And as you can see in the chart below, such a divergence hasn’t yet started to occur.

Bank of America Merrill Lynch

Another sign the bull detox has yet to befall the market can be seen through BAML’s proprietary Bull & Bear indicator. Designed to gauge market sentiment, the indicator flashes red when traders are seen as being too overexuberant. Right now, after months in that danger zone, the Bull & Bear index is back at a neutral level.

BAML also cites corporate earnings growth as a tailwind to stock prices, though it notes that global purchasing manager data is “rolling over,” signaling a slowdown to come. If it is, in fact, correct that profit expansion is set to slow down, it marks yet another driver that could hasten a risk sell-off.

With all of that in mind, you should be well-equipped to diagnose a worsening in conditions and get out ahead of the bull detox that has BAML so worried. Because if the increasingly volatile market has shown one thing over the past few weeks, it’s that timing is everything.

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