- The first half of the year has brought good news for many assets, but the rally could use a "breather," BofA analyst write.
- The five P's – pandemic, price, positioning, policy, and profits – are set to weigh on markets in the third quarter.
- Stocks may also fall preemptively, as investor jitters make lower Q4 profits show up in Q3 share prices.
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Bank of America is anticipating a preemptive slowdown in the third quarter as investors fearing the "five P's" pull back across asset classes, analysts wrote in a note.
The first half of the year has brought good news for many assets, but the "Wall St boom/bubble" could use a "breather," BofA's analysts wrote.
In their view, the five P's – pandemic, price, positioning, policy, and profits – look set to weigh on credit, stock, and commodity returns in Q3, partially in expectation of weaker company earnings relative to growth in the fourth quarter.
Pandemic
With Covid cases around the world ticking up due in part to the Delta variant, BofA expects growth and earnings expectations for this year and next to fall. That could lead to downward pressure on asset prices.
Price
The latest Covid wave comes as asset pricing is already robust, with the S&P 500 price-to-earnings ratio at dot-com bubble levels. Commodities and housing are also at or nearing historic valuations. US spreads between risk-free and junk bonds are exceptionally tight, as junk bond yields fell below inflation on Friday. (Prices rise when yields fall.)
Positioning
The analysts pointed to survey data showing fund managers pouring money into "late cycle" assets - those best suited for inflation and weak growth. In Q3, they see the S&P 500 falling below 4,000, a drop of roughly 8% from current levels, led by flagging tech stocks, which many investors (wrongly, in their view) see as a good defensive option.
Policy
Inflation across the developed world will force monetary and fiscal authorities to ease up on stimulus measures in the coming quarter. Moreover, prospects for Joe Biden's proposed $1.7 trillion infrastructure package have dimmed as the administration now pursues a slimmed down bipartisan deal.
China is still a "wild card" in terms of policy, the BofA analysts wrote, but the central bank seems wary of overheating the country's fragile financial sector.
Profits
Between potential future Covid restrictions, supply shortages, and likely growth deceleration, corporate profits are poised to feel the pinch in the second half of the year. Stocks may also fall preemptively, as investor jitters make lower Q4 profits show up in Q3 share prices.
