This week marked one year since COVID-19 turned the world upside down.
And for the first time since the pandemic hit, respondents to Bank of America’s Fund Manager Survey said the coronavirus was no longer the biggest risk to the bull market.
Roughly 220 respondents with a combined $630 billion in assets under management identified inflation as the biggest “tail risk” to the market, with a taper tantrum in the bond market a close second. While the coronavirus was identified as the third biggest threat to the market, it was cited by fewer than 15% of respondents – around half the level seen just a month ago.
All three of these concerns outpaced a bubble in the market, higher taxes, and stricter regulation under the Biden administration.
An all-time high net 93% of respondents said they expect higher inflation over the coming year, suggesting the rebounding economy is on its way out of recession. 91% respondents said they expect the economy to improve over the next year, and 48% said we’re in the midst of a “V-shaped recovery.”
The shift in focus comes as the U.S. vaccinates more than 2 million people a day and as hospitalizations and deaths from the coronavirus drop precipitously nationwide. While the daily average case count has declined sharply from the January peak, per-day case counts have plateaued.
It also comes as bond yields have spiked to pre-pandemic levels, with the “breakeven” rate between 5-year Treasury yields and inflation-indexed bonds jumping to its highest level in almost 13 years.
And the respondents indicated that a move in the 10-year Treasury note to the 2% level could spark a market correction with a greater than 10% drop. The 10-year yield rose to 1.669% on Wednesday, a level not seen since January 2020.
“Nobody believed that rates at 1.5% would cause an equity correction,” Bank of America chief investment strategist Michael Hartnett wrote in a note. “But the move from 1.5% to 2% is critical as 43% of investors now think 2% is the level of reckoning in the 10-year Treasury that will cause a 10% correction in stocks.”
But rising bond yields so far haven’t halted the bull market. The Dow and S&P 500 hit new record highs this week, while the Nasdaq has retraced nearly half of its correction from February.
Still, the dynamics of the market have shifted as yields have risen. The high-flying tech stocks that have dominated the market for the last decade have taken a beating, while value stocks have outperformed. 52% of respondents to the BofA survey expect that trend to continue.
The survey shows that “investor sentiment [is] unambiguously bullish,” Hartnett wrote, adding that it also “shows consensus is ‘cyclical,’ with high exposure to commodities, industrials, banks, discretionary, [and emerging markets] relative to the past 10 years, which is a drastic 180 from a year ago when investors were heavily invested in ‘defensives’ like cash, healthcare, staples, and utilities.”
With that in mind, fund managers have cut allocations to technology stocks to their lowest overweight level since January 2009, and the survey also found a pronounced shift in commodities to an all-time high. Managers have allocated their largest overweight position in banks since March 2018, and their largest shift to energy stocks since November 2018.