In 1881, 63% of the total value of the U.S. stock market was made up of railroad companies, which represented the cutting-edge technology of the day. Why, therefore, are the Magnificent Seven, who now account for 35% of the S&P 500, unable to achieve the same level? In his weekly Flow Show note, Michael Hartnett, global strategist at Bank of America, asks for that.
He notes that comparable extreme positioning concentrations have occurred in past bull markets, such as the outsize weighting of the tech sector in 2000, Japan’s rise to 45% of the MSCI ACWI ACWI in 1989, and the Nifty Fifty in the S&P 500 SPX back in 1972. The zeitgeist surrounding artificial intelligence is encapsulated by the Magnificent Seven (MAGS UK:MAG7), a collection of megacap tech firms, or more lately, the six omitting Tesla (TSLA), which has been somewhat decoupling. Hartnett finds no convincing reason why this trend cannot continue.
Two additional significant circumstances where mood and posture create the framework for pain trades are also noted in Hartnett’s analysis.
The dollar DXY staged a sort of resurgence in July after managing to halt its consistent year-to-date drop. The dollar index broke higher through its 50-day moving average toward the end of the month, which caused a sort of short-covering squeeze and resulted in a 3% gain.
Investors were the most underweight the dollar they have been in twenty years, according to Bank of America’s June Fund Manager Survey. According to a study conducted in July, the most prevalent strategy was shorting the dollar, with 33% of investors insuring against a further decrease, down from 40% in May.
Foreign currency watchers saw earlier this week that the dollar had broken above its 50-day moving average, a crucial technical indicator that points to a possible breakthrough. Hartnett contends that unless the United States resolves its debt issues, foreign investors will either hedge or completely eliminate their exposure to the dollar since the globe is still overly reliant on American assets.
Bank of America stated that it would advise selling the dollar once more if the index rose back to its 200-day moving average of 103.
The strong bearishness shown toward U.S. Treasurys is the other pain trade that Hartnett identified. In January, this asset class’s 10-year rolling return was minus 1.3%. U.S. Treasurys have returned 3% since then. A comparatively hawkish Federal Reserve is flattening the yield curve by lowering longer-term rates in comparison to short-term rates as a result of the cooling job market and decreasing U.S. growth, which is partly caused by AI adoption lowering labor demand.
The market is most likely not set up for a drop in U.S. 10-year yields BX:TMUBMUSD10Y from their current 4.38% as it waits for the Fed to take a more dovish posture, but Hartnett believes that the Fed is anchoring long bond expectations BX:TMUBMUSD30Y. Hartnett is therefore convinced by mood and positioning that a decrease to 4% that would make the greatest number of investors uncomfortable would qualify as a pain play.
