Investors pulled out a record amount of $19 billion from the stock market in the past week, according to Bank of America. This is the highest outflow seen this year, as the markets faced surging bond yields and doubts over the Federal Reserve’s interest rate policy.
Fed signals higher for longer rates
The main trigger for the massive outflow was the Fed’s policy meeting this week, where the central bank chief Jerome Powell hinted that interest rates could remain high for longer than expected by the markets. Powell said that the Fed would start tapering its bond-buying program soon, but did not give a clear timeline for raising interest rates.
The Fed also raised its inflation and growth forecasts for this year and the next, indicating that the economy is recovering faster than anticipated from the pandemic. However, Powell also acknowledged that there are still risks from the delta variant and supply chain disruptions.
The markets reacted negatively to the Fed’s hawkish stance, as higher interest rates make stocks less attractive compared to bonds and other assets. The 10-year Treasury yield jumped to 4.49%, the highest level since 2007, while the two-year Treasury yield reached its highest point since 2006.
Stock market bubble at risk of bursting
Bank of America warned that the higher for longer scenario could pose significant challenges for stocks and potentially lead to a difficult market environment in 2024 if rates persist at these levels. The bank’s strategist Michael Hartnett said that while the first half of 2023 brought relief with no recession, the second half has brought concerns over prolonged high-interest rates and tighter financial conditions.
Hartnett cautioned that these elevated rates increase the likelihood of a hard landing and risk a market “pop and bust” scenario in the first half of the year. He said that signs of a recession and a market bubble bursting are “lining up” for 2024, based on indicators such as the steepening of the 2-10 Treasury yield curve, the rise in unemployment and the personal savings rate.
Sector-wise performance and outlook
The outflow from stocks was broad-based, affecting both US and global equities. US stocks saw an outflow of $12.6 billion, while global stocks saw an outflow of $6.4 billion. The sectors that saw the most outflows were technology, consumer discretionary, health care and financials.
The sectors that saw inflows were energy, materials, utilities and real estate. These sectors are typically seen as more defensive and less sensitive to interest rate changes. Energy and materials also benefited from the rise in commodity prices, driven by strong demand and supply constraints.
Bank of America said that it expects the stock market to remain volatile in the coming months, as investors adjust to the changing interest rate environment and the Fed’s policy moves. The bank advised investors to be selective and focus on quality stocks with strong earnings growth and cash flow generation.