As Central Banks Tighten, the Tech Stock Rally Faces 'trouble', Says Bank of America

Anticipating a prolonged surge in technology stocks driven by the enthusiasm surrounding artificial intelligence in 2023, investors may face challenges as central banks pursue a course of tightening monetary policies, cautioned analysts at Bank of America in their recent communication on Friday.

Within their weekly "Flow Show" report, spearheaded by Michael Hartnett, the team conveyed their view that the latter half of the year could entail difficulties rather than marking the advent of a new era characterized by AI-driven rules.

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Citing their observations, they highlighted a pivotal correlation witnessed in markets over the past 15 years, emphasizing the strong link between central bank liquidity and tech equities. They noted that during this period, central bank liquidity surged remarkably from $5 trillion to $25 trillion, a phenomenon that closely paralleled the ascent of tech stocks, as evidenced by the Nasdaq's ascent from 2,000 to 16,000.

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However, the landscape has shifted as central bank balance sheets have contracted by $3 trillion. Despite this contraction, the Nasdaq Index continues to exhibit an appetite for new highs. The analysts drew a parallel to the concept of "excess savings" for the general public, cautioning that a similar notion of "excess liquidity" might soon dissipate within the realm of Wall Street.

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An illustrative chart appended by the analysts underscores their point. It serves as a reminder for those bullish on the emergence of AI's potential ("Nouveau bulls"), advising caution against a potential "double top" scenario in the weighting of the prominent "magnificent seven" mega-cap tech stocks within the S&P 500. The list comprises Nvidia Corp. NVDA, -2.43%, Apple Inc. AAPL, +1.26%, Amazon.com Inc. AMZN, +1.08%, Microsoft Corp. MSFT, +0.94%, Alphabet Inc. GOOG, +0.21%, Tesla Inc. TSLA, +3.72%, and Meta Platforms Inc. META, -0.44%.

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While the springtime earnings of chip manufacturer Nvidia fueled an AI frenzy, leading to a robust upswing in the stock market, the breadth of this participation has remained limited despite sporadic instances of expansion. The rally experienced a setback in August, with the rise in Treasury yields, culminating in the highest rate observed on the 10-year note since 2008.

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During August, the S&P 500 experienced a 3.9% retracement, leaving it with a year-to-date increase of almost 15%. In parallel, the technology-focused Nasdaq Composite retreated by 5.3% this month, yet retains an impressive year-to-date growth of nearly 30%. Conversely, the more cyclically-oriented Dow Jones Industrial Average declined by 3.3% in August, reflecting a modest year-to-date gain of 3.8%.

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In the context of a fluctuating trading session, U.S. stocks displayed modest gains on Friday afternoon. This followed Federal Reserve Chairman Jerome Powell's assertion that the central bank might need to further elevate interest rates to manage a robust U.S. economy and counter inflation. Powell emphasized the prudent and cautious progression of monetary policy to reassure investors.

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