Bank of America Hartnett: Contrarian investors are quietly awaiting two major signals, ready to shift to a risk-off mode at any time.

Michael Hartnett, Chief Investment Officer at Bank of America, has warned that despite the current market sentiment being in an extremely bullish phase, contrarian investors are preparing for a sudden shift in market sentiment and are ready to switch their portfolios to a "risk-off" mode at any moment. In the latest Flow Show report, Hartnett stated that the core triggers for this potential shift lie in two upcoming key signals: the potential compromise in the US-Iran conflict and the forthcoming US midterm elections. Any sudden geopolitical de-escalation or unexpected change in political power could quickly break the fragile consensus supporting the unanchored rise of risky assets. The report highlights that market funds have begun to hedge against the risk of currency devaluation in advance, with safe-haven assets experiencing a massive influx of capital. Recent data shows that gold and cryptocurrencies attracted over $10 billion in total funds in a single week, while the US stock market faced significant capital outflows, highlighting the undercurrents of funds beneath the surface prosperity and investors' defensive psychology. Meanwhile, the bond market is vying for dominance in global asset pricing. Hartnett believes that whether policymakers can successfully suppress long-term Treasury yields is not only crucial for the financing environment of AI capital expenditures but also the key determinant of whether the current risk appetite in the stock market can continue. Two Reversal Signals: The Waiting List of Contrarian Investors Hartnett clearly outlined two major "reversal risk" opportunities that contrarian investors are waiting for in the report: First, a de-escalation in the US-Iran situation and the final drop in oil prices. If there is substantial easing in the US-Iran conflict, oil prices will face one last round of downward pressure, at which point the market's optimistic sentiment regarding EPS expectations may peak, providing an entry window to short risky assets. Second, the results of the US midterm elections. Hartnett pointed out that if the Republican Party loses control of the Senate or the governorship of Texas, it would have a negative impact on the market. The logic is that voters are indicating through their ballots that affordability and controlling inflation are of higher political priority than tax cuts, deregulation, or driving up stock prices, which would fundamentally shake the policy foundation of the current market consensus. Before these two signals are triggered, Hartnett believes that the market will continue its "grinding higher" pattern without a leading sector, while contrarian investors remain highly vigilant, ready to switch to risk-off mode. Capital Flows and Sentiment Indicators: Safe-Haven Assets Encounter Strong Buying In the recent market turbulence, capital flows have shown strong "anti-devaluation" characteristics. According to the Bank of America report, funds are being significantly withdrawn from traditional risky assets and are flowing into alternative safe-haven assets. Specifically, gold registered an inflow of $7.3 billion, while cryptocurrencies saw an inflow of $3.2 billion, both marking the largest scale since October 1995. In stark contrast, the US stock market faced an outflow of $4.4 billion, the first outflow in five weeks; high-yield bonds also recorded an outflow of $700 million. Although the technology and materials sectors still saw inflows, the overall capital landscape has shown defensive tendencies. In addition, the Bank of America Bull & Bear Indicator rose further to 9.7 last week, nearly touching its historical high. Hartnett believes this extreme bullish indicator is mainly driven by the broadening of global stock indices and increased hedge fund positions in gold and short positions in VIX. Despite the S&P 500 index experiencing a slight increase after triggering a "sell signal" on May 26, the extreme positioning has buried hidden dangers for a potential correction. Bond Market Pricing Power: Yield Becomes the Core Battlefield Michael Hartnett stated in the report that currently, bond trading is about information, while stock trading is about ideas. In the AI investment frenzy, AI bonds are viewed as leading indicators. The report notes that only when the 30-year Treasury yield drops below 5% will the underperformance of AI spenders (MAGS) and AI builders (SOX) relative to AI adopters come to an end; however, this target seems hard to achieve in the short term. Hartnett believes that the new Federal Reserve Chairman, Waller, attempted to balance inflation and the yield curve in his speech at Jackson Hole. Although the yield curve between the two-year and thirty-year Treasury rates flattened significantly post-speech, and the dollar rebounded, the broader risk appetite did not recover as expected, with Treasury yields even breaking through the critical intervention level of 4.7%. Michael Hartnett believes that the policy combination of Bostic and Waller must prevent US Treasury yields from rising further; otherwise, long-term trading will face immense pressure. Policy and Positioning: Central Bank Turnaround and the Collision of the "No Landing" Consensus From a market positioning perspective, investors are currently immersed in a perfect consensus of "no macro landing, Fed not raising interest rates, AI capital expenditures not being cut, and Democrats not sweeping." Asset allocation reflects a pattern of going long on stocks, long on investment-grade bonds, and short on government bonds and the dollar. However, to hedge against the risk of such high consensus, Michael Hartnett insists on going long on commodities like gold and global natural resources. On the policy front, global central banks are quietly changing course. The report points out that in the last three months, central banks around the world have implemented 13 rate hikes, exceeding the 12 rate cuts, with Bank of America expecting a scenario of 17 rate hikes versus 4 rate cuts by the end of the year. Hartnett believes that the interest rates hikes by central banks help to align with the US Treasury's bond and forex interventions to suppress long-end yields this is critical for financing the AI capital expenditure boom and preventing consumers from increasing precautionary savings out of concern for the $40 trillion national debt. Notably, the US Treasury's bond buyback program will end on November 4, just one day after the US midterm elections. On the political front, Trump's economic approval rating (35%) and inflation approval rating (28%) have once again declined. Hartnett pointed out that a swift end to the US-Iran conflict is the most direct path to boosting approval ratings, which is the core logic behind contrarian investors' close attention to the situation in Iran. This article is reproduced from "Wall Street Insights," author: Dong Jing GMTEight editor: Zheng Yuyang.