- Bank of America Merrill Lynch predicts "capitulation" for the bull market in 2018, with the S&P 500 peaking at 2,863.
- Strategist Michael Hartnett said the firm is prepared to "downgrade risk aggressively" once it sees the triggers in place.
- A shift from passive to active in investor allocations would be one of the signs that the rally is about over.
Bank of America Merrill Lynch sees a scary good news-bad news scenario unfolding in 2018: A solid push higher in the first half followed by all sorts of potential trouble after.
The S&P 500 would peak out around 2,863 in the scenario, or about 11 percent higher than Monday's close. Bond yields are expected to rise, with the benchmark 10-year Treasury note hitting 2.75 percent as global GDP growth reaches 3.8 percent.
That setting assumes three things: the "last vestiges" of stimulus from the Fed and other central banks, the passage of tax reform in Congress, and "full investor capitulation into risk assets" on better-than-expected corporate earnings.
After that, though, things get considerably sketchier as the second-longest bull market in history runs into trouble.
"We believe the air in risk assets is getting thinner and thinner, but the Big Top in price is still ahead of us," Michael Hartnett, chief investment strategist at BofAML, said in a report for clients. "We will downgrade risk aggressively once we see excess positioning, profits and policy."
Indicators that market positioning has gotten out of hand and signaling a fall would include active funds attracting more money than passive (there's a $476 billion gap this year in favor of passive), and portfolio allocation for equities exceeding 63 percent, a level currently at 61 percent.
"The game changer is wage inflation, which on our forecasts is likely to become more visible," said Hartnett, who projects that salaries could rise 3.5 percent and push the consumer price index up 2.5 percent and convince the Fed that it's close to meeting its 2 percent inflation goal.
However, that cuts both ways: Should wage inflation again fail to materialize, Hartnett said "the era of excess liquidity" continues, bond yields would fall and the Nasdaq tech barometer would go "exponential." That would signal a bubble that might not end until 2019, when a bear market would be triggered by "hostile Fed hiking, Occupy Silicon Valley and War on Inequality politics."
Reference: CNBC
Read more: https://www.cnbc.com/
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