US stock indices closed in the red for two consecutive weeks, the first such run since March, leaving the S&P 500 just 3% below its record high. Bank of America says markets are failing to factor in existing risks and warns that a 7–8% fall could follow if negative events materialise. The final week of July puts that thesis to the test as the tech giants report.
US stock indices have closed in the red the last two weeks, something that hasn’t happened since March. The market has weathered both the armed conflict in the Middle East and rising expectations of a tighter Fed policy, along with the associated rise in Treasury bond yields. Even so, the S&P 500 sits 3% under its record high.
Bank of America sees no fear priced into equities
According to Bank of America, markets are operating on the assumption that everything is going well and are failing to factor in existing risks. Investor expectations for profit margins, five-year forward earnings growth and other indicators sit at record levels, while risk premiums have slipped to 20-year lows. That complete lack of fear in the equity market could lead to a 7–8% fall in the S&P 500 if negative events materialise.
Cash flow replaces profit as the market’s test
Adverse factors include the conflict in the Middle East and everything tied to it: the rally in oil prices, Treasury yields and the increased likelihood of a Fed rate rise. Bank of America also notes the low return on investment in AI and the high costs companies incur funding research in this area.
Because of this, investors are focusing on cash flow rather than profit. Alphabet’s negative cash flow sent the entire market tumbling.
In the final week of July, more than a third of S&P 500 companies by market capitalisation will report their results. If cash flow issues emerge at Microsoft, Meta Platforms, Amazon and Apple, the correction in the broad stock index risks continuing.
The case for relief
On the other hand, the stock market may breathe a sigh of relief. The ceasefire in the Middle East, coupled with de-escalation, falling oil prices and a decline in Treasury bond yields, is reducing the geopolitical risk premium.
At the same time, the Fed may be able to afford to be less ‘hawkish’ than investors expect. A ‘TACO’ rebound, coupled with the federal funds rate being held steady, could breathe new life into the S&P 500. The key is that the tech giants’ earnings reports do not disappoint.
Source: ActionForex
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