Famous BofA Indicator Flashes Rare, Contrarian ‘Buy’ Signal

It’s time to “nibble.”

That’s according to BofA’s Michael Hartnett who, despite what sometimes feels like religious conviction in the notion that it’s best to “sell the last hike,” was compelled this week to bow before the bank’s pseudo-famous Bull & Bear Indicator, which flashed a rare contrarian “buy” signal.

For those unfamiliar, this indicator is an indicative metric. It’s not a performance measure and it’s not a benchmark of any kind. BofA goes out of its way to say what it isn’t. What it is, though, is fairly reliable even if, according to a very long list of disclaimers, you’re not supposed to rely on it for anything. It hit 1.9 this week. Anything below 2.0 suggests “extreme bearishness,” an ostensible opportunity.

The decline into extreme bear territory was driven by outflows from EM debt and high yield bonds, which have seen redemptions for 12 and seven straight weeks, respectively. In addition, global equity funds shed a modest $5.2 billion over the week. Also, cash levels in BofA’s Global Fund Manager survey are back to 5.3%.

Three of four BofA trading rules now flash a “buy” signal. In addition to the Bull & Bear Indicator below 2.0 and FMS cash levels above 5%, a flow rule was triggered when redemptions as a percentage of AUM over four weeks rose beyond 1%. The one rule not flashing “buy” is a breadth indicator. For that, more than 88% of the All-Country World Index would need to be oversold.

For now (where that means for three or four weeks), investors are “sufficiently bearish” for 5% (or thereabouts) to serve as a ceiling for 10-year yields and for 4200 SPX to be the floor for US equities, Hartnett said, adding that the trading rules “almost always work for a trading rally unless Wall Street is experiencing a two-standard deviation exogenous shock.” He mentioned WorldCom, Lehman and Russia’s invasion of Ukraine.

The backtest, shown above, suggests that if past is precedent (and although I shouldn’t have to say this: It might not be), global equities have upside of more than 7%.

Any trading rally this month and next is “best played via most the oversold assets,” Hartnett went on. Those include REITS, banks, retail shares, small-caps, utilities, staples, Chinese assets and, of course, 30-year Treasurys.

There are caveats aplenty. Anyone inclined to trade tactically should “nibble” and “rent” not “gorge” and “own.” Rallies, Hartnett said, “should be sold.” For a “big low” you need extreme bearish positioning, a recessionary decline in corporate profits, falling GDP forecasts and easier monetary policy (or expectations thereof). None of those boxes are checked.

Only once those boxes are checked will the stage be set for “big upside,” Hartnett wrote, noting that markets would need to see “rising defaults, delinquencies, a small business credit crunch and a higher unemployment rate” to signal monetary policy isn’t impotent after all.

As for what could “short-circuit” (as Hartnett put it) the “buy” signal from the Bull & Bear Indicator, oil above $100 on a Middle East shock “and/or” US yields rising materially above 5% could undercut the prospects for an “oversold rally” in Q4.