Two years of steady gains have made stocks feel like a sure thing. A Friday note from BofA suggests investors should not get too comfortable.
Michael Hartnett's team warned that the bull market could face a major obstacle within a few months. The trigger is the November midterm elections, which the bank says could give Democrats control of Congress.
BofA frames the vote as a choice between two opposing populist approaches to the economy. Either way, the bank says, the market is facing a turning point.
Until that is sorted out, Hartnett's team told clients to stay cautious.
The K-shaped idea gets its name from the shape the recovery traces. One line points up for wealthy families, whose stocks and homes keep rising, while another line points down for lower- and middle-income families squeezed by faster inflation and a weaker job market.
Think of it as two economies running at the same time, one doing fine and one falling behind. That split matters because stock gains have been quietly doing the heavy lifting for growth.
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BofA says growth has been supported largely by the wealth effect, which is the tendency for investors to spend more when their portfolios look bigger. The market has added about $9 trillion in value over the past two years.
That paper wealth is a straight line from the stock market to the shopping mall. When people feel richer, they spend more.
The catch is that what goes up can go down. If stocks reverse, investors nursing paper losses tend to trim their spending, and that slowdown feeds straight back into the economy.
The other warning sign is in the bond market. Yields are expected to keep climbing, BofA says, because investors are jittery about inflation and the government's fiscal path.
In the bank's downbeat scenario, much higher yields would pressure risky investments and burst the AI bubble. Treasury yields have already moved higher on inflation worries, and so far the stock market has taken it in stride.
The 10-year Treasury yield, which is the rate the government pays to borrow for a decade, is hovering around 4.67%. That is above the 4.5% level investors watch.
When Treasury yields climb, safer investments suddenly pay more, which makes stocks look less attractive by comparison. BofA's strategists call rising yields a "canary in the coalmine."
The strategists put the risk in blunt terms. "Bonds end booms and bubbles, and this one ends once 'higher yields-lower dollar' vigilante event forcing fiscal policy U-turn, and asset allocation from stocks to bonds rise."
BofA is not alone in expecting a bumpy stretch. Other forecasters say volatility tends to increase as the midterms get closer, and Oppenheimer analysts note that in midterm years with a second-term president, the S&P 500 often corrects in the third quarter.
For your portfolio, the practical question is not who wins the election. It is whether the next few months feel like progress or patience, and history says patience is the more likely answer.
The vote will land, the market will move, and the flat stretch in between will probably matter less than it feels like at the time.
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