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Bank of America details 3 reasons to stay bullish on cheapened tech stocks left ‘bruised’ by rising rates — and outlines the signals to watch ahead of a possible bearish turn

Business

Julius Shakari, from California in full PPE gear, takes photos with his friend in front of the Charging Bull

Summary List Placement

Leading investors are using the market’s battering of tech stocks last week to buy cheapened household names.

With forecasts of a strong bounce back in economic growth this year, investors have been cashing in on their expensive technology stock holdings in favor of cheaper shares of companies whose performance is closely correlated with the health of the economy – known as ‘value’ stocks – to capitalize on the rebound.

But this optimism is leading to profit-taking in the fixed income market as well, as investors ditch government bonds that had reached record-high prices levels – and record-low yields. 

Last week, investor anxiety over rising yields came to a head as the 10-year US treasury hit a 14-month high of above 1.7%, reflecting the concern that the super-low interest rate environment that enabled record high tech stock valuations could soon come to an end. 

But even as this switch into value stocks and out of bonds continues, some investors are using the opportunity to snap up some of those tech stocks that suddenly look a lot cheaper, before they bounce back more aggressively.

“Stay bullish. Buy cyclicals, value, and start taking a fresh look at tech, already bruised by rising bond yield concerns,” strategists at Bank of America including Ajay Singh Kapur wrote in a recent note.

Rising rates are often viewed as bad for tech or ‘growth’ stocks which have less of a correlation to the economy, as it can affect valuations. If interest rates rise, then future cash flows have to be discounted by a higher interest rate. So the flows become worth less, and with the current very ambitious valuations based on future growth valuation are going to have to come down when the discount rate – the interest rate – goes up.

But time is of the essence, as investors are already taking up the opportunity. The S&P Growth index, a basket of mostly tech stocks, rallied 2.9% over the last two weeks, outperforming value for the first time since the start of February.

3 Reasons to Stay Bullish

For Bank of America, the stock market is still firmly in a bull market, for these three reasons:

Massive free liquidity growth

The availability of liquid assets, like cash, is one of the most important drivers of asset prices, and when financial system is ‘flush with liquidity’, equity markets outperform, BofA said.

A key indicator for this is the size of central bank balance sheets, and with policymakers like Federal Reserve Chairman Jerome Powell signaling that record asset purchasing will not be cut back until the US economy shows signs of strong and stable growth – liquidity isn’t slowing down.

With strong liquidity, equity market growth should remain supported.

An exceptionally strong EPS growth cycle

As the world exits the COVID crisis, a new growth cycle is getting underway. Returns for investors are best during the first and final quarters of a cycle, meaning markets are entering what Bank of America says is a robust period.

Indeed, 89% of BofA’s 66 growth indicators across economies and sectors are bullish/neutral at the moment, indicating that this is still upcycle for EPS growth.

“Trend indicators of growth are on a strong run… spelling out an upbeat earnings outlook,” it added.

BofA growth indicators

Substantial market breadth

One of the ways the market ‘talks’ to investors is through the S&P500 breadth thrust indicator, which shows the momentum, BofA said, signalling a potential new bull market when it moves from a level of below 40% to a level above 61.5% within any 10-day period.

The last trigger came on 8 October and a thrust is “in action” right now, BofA added.

These three components combined has created a “sweet spot” for equity investors, it said. As a result, “portfolios should be bullishly positioned, and left untouched by the latest bout of negativism,” BofA wrote.

Where there’s a bull, there’s always a bear

Market conditions change and this bullish cocktail is still at the whim of market dynamics.

“When free liquidity tightens, when the EPS growth cycle is enfeebled, and when the ‘tape’ breaks down, we will worry,” the note said.

A tapering of the Fed’s asset purchasing is probably the biggest threat for stock market bulls. Investors are still wary of a so-called “taper tantrum” – an event that occurred in 2013 when bond yields spiked dramatically, when the central bank signaled it was ready to shrink its balance sheet.

The Fed has gone to some lengths to reassure markets that it has no plans to adjust monetary policy, or its asset purchases any time soon. 

So, this time around, even if growth were to mellow, and enter the second quartile of the cycle, the bull market should remain strong, BofA noted.

“The strong liquidity, coupled with the support of a healthy market breadth should help to keep equities afloat… The strong growth is just an added layer of comfort for us,” it said.

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