Fragility risks in the market are at the highest ever, as investors keep looking to the Federal Reserve to extend a massive stock-market rally that repeatedly has risen to fresh records this year, according to analysts at Bank of America Corp.
“Markets remain overly dependent on the Fed and are inherently fragile,” the bank’s equity-linked analysts said in a BofA Global Research note Tuesday. Two of the four biggest “fragility shocks” since 1928 were seen in the S&P 500 index in just the last three and a half years, they said in the equity derivatives report.
The stock market is vulnerable after staging a huge recovery from last year’s trough in the Covid-19-induced selloff — a downturn that prompted the Fed to swoop in with rescue programs designed to support markets and an imperiled economy. The S&P 500 has soared nearly 90% from the Covid low for the second-fastest rally for U.S. equities since 1928, the BofA Global Research report shows.
Investors have worried that signs of rising inflation in the economic rebound could result in the Fed tapering its asset purchases or raising its benchmark interest rate sooner than anticipated. One concern is that a less accommodative Fed could hurt the valuations of high growth stocks.
The market’s reaction to a weaker-than-anticipated jobs report on Friday underscored its reliance on the Fed, as the “bad news” was treated as “good news,” according to the analysts, who pointed to the jump that day in the technology-heavy Nasdaq Composite index. In other words, stock-market investors took the disappointing jobs report as reason for the central bank to remain dovish.
“The Fed has their pedal to the metal trying to restore the pre-Covid labour market,” the analysts wrote. “While the Fed can’t afford to appear uncertain, their dogmatic confidence that inflation won’t become problematic is equally suspect.”
U.S. stocks fell Monday and extended losses into Tuesday. The Nasdaq Composite index
COMP,
-0.19%
was down 0.2% in afternoon trading, while the S&P 500
SPX,
-0.92%
fell 1% and the Dow Jones Industrial Average
DJIA,
-1.38%
was 1.5% lower.
“Markets will likely need to walk a Goldilocks tightrope over the summer,” the Bank of America analysts said. That means investors will need to navigate increasingly “tricky territory” where they’re avoiding both the upside risks of inflation and overheating as well as the downside risk that “herd immunity remains elusive” as the pandemic persists, according to their note.
Risks on both sides of the tightrope could be catalysts for market shocks.
“Fragility will strike again, as valuations and positioning look stretched,” the analysts warned. “Trading liquidity continues to be poor.”
