Wall Street Warns Bond Market Rout Will Catch Up With Stocks

(Bloomberg) -- The era of abundant liquidity is coming to an end and stock markets trading at record highs won’t be able to stay immune for much longer, according to Bank of America Corp. strategists.

This is the latest in a series of warnings by top Wall Street brokers that the exuberance, which has fueled the rally in European and U.S. equities, may not last. Stocks have so far largely ignored a worsening rout in bond markets, where investors are pricing in a swift tightening of monetary policy, as robust earnings and lack of investment alternatives drive risk appetite.

“This divergence is unlikely to sustain and the risk is equities are forced to price in the increasingly unfavorable policy environment,” BofA’s strategists, including Gonzalo Asis, wrote in a note on Tuesday.

Stocks in the U.S. and Europe are hovering around record highs, following another solid earnings season that saw companies reporting results that beat analyst expectations. With valuations increasingly stretched, and economic indicators showing that global growth is decelerating, more strategists are starting to warn that the tapering of central bank asset purchases and potential rate hikes may strip markets of excess liquidity to sustain the rally.

“We think it’s only a matter of time before equities are forced to price in the increasingly unfavorable policy environment for a market addicted to central bank liquidity,” said BofA’s strategists.

BofA is not alone in its view that a reckoning for stocks is nigh.

“The fundamental picture for stocks is deteriorating as the Fed starts to tighten monetary policy and earnings growth slows further into next year, turning outright negative for some companies,” Morgan Stanley’s Michael Wilson wrote in a note on Sunday.

Markets are rising because retail buyers keep using their excess cash, while institutional investors are staying fully invested for technical reasons, such as pressure to perform and strong seasonal trends at the end of the year, according to Wilson.

“We think that this bullish trend can continue into Thanksgiving, but not much longer,” he said.

However, there are still plenty of stock market fans out there. Goldman Sachs Group Inc. strategists remain overweight on equities, saying there’s no alternative to stocks while bond yields are low, and still see “healthy levels” of growth into next year.