(Bloomberg) — A toxic mix of rising interest rates and lower corporate earnings doesn’t bode well for equities and credit this year, according to Bank of America Corp.
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“Rates up and profits down = bad combo for credit and stocks,” strategists led by Michael Hartnett wrote in a note. They see negative returns for both asset classes in 2022, with a “rates shock” in the first half of the year followed by “recession panic” in the second.
The prospect of more hawkish Federal Reserve policy has sent shock waves across equity markets this year, with the MSCI World Index down 5%. The Nasdaq 100 entered correction this week as growth stocks such as technology, which are valued on future growth expectations, have been the hardest hit. In credit markets, rate hike fears are raising borrowing costs for almost every asset class, with the majority of indexes this week showing the worst total return losses for the start of the year in decades.
BofA’s strategists say that despite widespread acceptance that rate hikes are coming, the longstanding accommodative environment means that expectations are too low. They see the Fed as “hysterically behind the curve” and believe the central bank should hike interest rates by 50 basis points at its meeting next week.
As for equities, Hartnett said that leading indicators for profits — such as New York manufacturing activity — are starting to head south, in a bad sign for highly-correlated stocks. The strategist also sees particular impact from rate hikes on former market winners like semiconductor and homebuilders stocks.
Despite the global equity market selloff, stocks have attracted $52 billion in inflows in the first 13 days of trading this year, according to EPFR Global’s fund flows data cited by BofA. That’s only marginally down from the $53 billion that poured in over the same period in 2021. In contrast, credit and bond funds have recently been hit with outflows.
“Fed is hiking into overvalued credit and equity markets and Fed tightening always ‘breaks’ something,” Hartnett wrote.
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