Bernstein Disagrees With BofA That Stocks Have Seen Capitulation

(Bloomberg) -- Stock markets are yet to see full capitulation, Sanford C. Bernstein strategists said, taking a contrary view to that of Bank of America Corp., whose survey showed that investors have already thrown in the towel.

“We have not yet seen capitulation in outflows from equity funds,” strategists Mark Diver and Sarah McCarthy wrote in a note on Wednesday. “In fact outflows, excluding Europe, have only just begun.” 

By contrast, Bank of America’s July global fund manager survey showed on Tuesday that full capitulation had been reached after investor allocation to stocks plunged to the lowest since October 2008, while exposure to risk assets dropped to levels not seen even during the global financial crisis. 

Global equity markets have slumped this year on fears of a looming recession as hawkish central banks race to tame scorching inflation. Even so, stock funds have seen $181 billion in net inflows in 2022 while bond funds have been hit by $206 billion of outflows, according to a Bank of America note last week citing EPFR Global data. 

“We may already have seen capitulation from bond funds,” Bernstein strategists wrote. “Significant selling in the second quarter has been followed by two weeks of net purchases so far in the third quarter.”

Bernstein strategists said that global equity fund flows have “remained remarkably resilient this year” and that most of the inflows occurred during the first quarter, followed by only minor selling of $8 billion in the second quarter even as markets were rocked by the highest inflation in decades and rising risks of economic stagnation.

Stocks have attempted to rebound recently on optimism that US inflation was starting to peak and that would spark a shift in the Federal Reserve’s policy.

Tracie McMillion, head of global asset allocation strategy at Wells Fargo & Co., said this rally was premature. “We will see capitulation and we will see value coming back into the market. But we just think it’s too early in this bear market, really too early in the Fed’s tightening cycle, to call the all clear,” she said on Bloomberg Radio.

Bernstein said its short-term indicator of investor sentiment is neutral, although the longer-term indicator is at extreme pessimistic levels, a divergence which they said “suggests that there may be strong returns over a period of a year or more, but in the short term there may be further downside to equity markets before a tactical capitulation level is reached.”

Bank of America strategists said their custom bull & bear indicator remains “max bearish,” which could be a contrarian signal for a short-term rally in stocks and credit in coming weeks. But Wells Fargo’s McMillion pointed to the aftermath of the 2008 crisis when investor sentiment had also hit a low, but it took months for the stock market recovery to gain traction.

Read More: ‘Full Capitulation’ May Mean Opportunity Knocking: John Authers

“So even though we are seeing these high levels of investor pessimism, it doesn’t necessarily mean that we’re through this,” she said. “The Fed has just started tightening. So we’ve got a ways to go as they work to bring inflation lower.”

Market participants are looking to the corporate reporting season for the next major trigger for stocks. Negative news during the second-quarter earnings season could lead to “proper capitulation,” Bank of America strategists led by Michael Hartnett said in a note on July 14. 

Morgan Stanley strategists also said late on Tuesday that the earnings season could be a negative catalyst for equities in the coming weeks and that they remain “skeptical” that margin pressures would ease beyond the quarter against the backdrop of high costs and a stronger dollar.

(Updates with details from Bank of America, Wells Fargo from first paragraph)

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