BofA Bull & Bear Indicator Hits 2021 High! Market Overheating Warnings Rise as AI Bubble and Rate Hike Risks Take Center Stage

Bank of America's closely watched stock market sentiment gauge has flashed another warning signal. The bank's strategist team noted that the 'Bull & Bear Indicator,' which measures investor sentiment, rose slightly from 9.5 to 9.6 last week, reaching its highest level since the pandemic rebound peak in 2021.

According to Business Insider, this indicator is known for its 'contrarian' logic. When market sentiment becomes overly optimistic and investors are broadly bullish, the indicator triggers a 'sell' signal. Conversely, when investor sentiment turns extremely pessimistic, it generates a 'buy' signal.

The indicator first triggered a 'sell' signal in May, based on factors including hedge fund positioning, fund flows between stocks and bonds, and technical indicators. Historical patterns show this signal often precedes market corrections.

A team led by BofA's chief strategist Michael Hartnett stated in a report released last Friday (24th) that since 2002, the indicator has triggered a 'sell' signal 17 times.

Within three months of the signal, global equity markets have averaged a 2% to 3% decline, with maximum drawdowns ranging between 15% and 20%.

The strategists added that once the indicator triggers a 'buy' or 'sell' signal, it typically persists for about one to three months.

The bank pointed out that interest rate movements could become a potential risk weighing on markets, especially as expectations grow that the Federal Reserve (Fed) may restart its rate hike cycle in the coming months.

According to the CME Group's FedWatch tool, markets currently assign a 91% probability that the Fed will raise rates at least once before 2027.

BofA strategists noted that investors have not yet viewed rising interest rates as a major threat to equities. Market funds continue to flow into risk assets like stocks, creating a bullish pattern of 'buying everything except bonds.'

However, if the U.S. government, aiming to cool stock market gains or due to political factors, accepts Fed rate hikes, it could undermine market confidence and prompt investors to reassess risk asset valuations.

Meanwhile, the market has recently begun questioning the sustainability of the AI investment boom, yet investors continue to heavily favor risk assets as global stock markets approach historic highs.

The bank's latest fund manager survey shows that an increasing number of global investors now view the AI stock bubble as the market's biggest tail risk, yet their equity holdings remain near full capacity, with cash allocations dropping to a historic low of 3.6% in July.