Stock Surge Is a Bear-Market Trap With Curve Inverted, BofA Warns

The strategists recommend investors sell out-of-the-money calls to hedge against both downturns as well as any potential short-term run-ups, which they say will be “limited.”

Bulls argue that despite the Fed’s push to slow growth, companies will still be able to deliver profit gains that justify valuations. Corporate America, in particular, is most insulated from the impact of sanctions on Russia, at the same time that bonds around the world have been in freefall.

BofA’s strategists said it would take softer inflation for stocks to be able to add to the latest gains — something the bank’s economists don’t expect. They also warn that any easing of tensions in eastern Europe would remove a threat to growth but also give the Fed cover to hike faster.

The rates markets, for one, are exhibiting a lot more signs of stress. An increase in rates volatility over the past 10 days, as measured by the MOVE Index, relative to falling equity-markets volatility, as measured by the VIX, has been the largest since 2009 and is one of the biggest ever, BofA says. Following the 2009 episode, the S&P 500 fell 7% over the following six weeks.

Stocks registered a big pullback at the start of the year, and investors are now wondering if the market’s mired in a bear market. “We believe so,” Katerina Simonetti, senior vice president at Morgan Stanley Private Wealth Management, said in a Bloomberg Radio interview.

“We believe that yes, in fact, this is a bear market, we have been in a bear market for quite some time,” she said. Her team came into the year worried about valuations, Fed tightening, inflation and a growth slowdown, and the war in Ukraine worsens many of those concerns.

“Now, this is not to say that there are no pockets of opportunity in this market, there absolutely are, and investors should be in position to take advantage of them,” Simonetti said. “But they are bear market rallies and they have to be seen as such.”

–With assistance from Isabelle Lee and Lu Wang.