The stock market's plethora is close to forecasting a sharp sell-off, Bank of America strategists said on Monday.
Stocks rose sharply on Monday as fears about rising Treasury bond yields gave way to a resurgent risk appetite. Stocks most closely linked to the resumption of economic growth beat expectations, with major indexes nearing record highs. After questions were raised last week about whether the stock could maintain its elevated valuations, Monday's purchases signaled that investors believe so.
According to strategists led by Savita Subramanian, it is this overwhelming bullish activity that can negate the record rally. The Bank of America Sell Side Indicator, which tracks the average recommended share allocation by Wall Street strategists, rose to 59.2 percent from 58.4 percent in February. The indicator is near the highest point in the last ten years and is 1.1 points from the "sell" warning.
The last time such a signal was given was in June 2007. The yield on average was negative 13% year-on-year for several years after the "sell" threshold was last crossed, strategists said in a note.
So far, the indicator is in "neutral" territory, but increased optimism suggests a muted yield of the stock market over the next 12 months. The indicator forecasts a yield of just 7% over the next year, less than half the average forecast of 16% since the Great Recession.
Rising Treasury bond yields and higher valuations also suggest stocks are poised for a decline, the team said. While yields fell from a peak of 1.614% last week, a rise to 1.75% would mark a "tipping point" for asset dispensers to transfer cash from stocks to bonds. And stretched stock price multipliers point to below-average yields of 5%, according to the bank.
Those who still plan to stay in the market should bet on sectors "tied to the real economy," strategists say. Cyclical, low-cap stocks and stocks are more likely to outperform as the economy resumes. Conversely, stocks should be avoided, which led to growth last year, the team added.