Key Points
- Bank of America warns that the year-end stock rally is at risk. The danger is a “dovish” Fed signaling rate cuts, which could imply a weakening economy.
- Investors are currently optimistic, with the market pricing in a 90% chance of a December rate cut.
- A surprisingly soft stance from the Fed could kill market confidence and end the rally.
- BofA recommends investing in mid-cap stocks and cyclical sectors like retail and homebuilding.
The stock market’s strong year-end rally could be in jeopardy, and the threat is coming from an unlikely source: the Federal Reserve’s perceived softness on the economy, according to strategists at Bank of America.
Right now, investors are feeling confident. The S&P 500 is just a breath away from a record high, and the market is banking on a perfect scenario where the Fed cuts interest rates while the economy stays strong and inflation falls.
But that optimism could shatter if the Fed signals it’s too eager to cut rates at its meeting next week. According to BofA strategist Michael Hartnett, such a “dovish” move might suggest that the Fed sees a larger economic slowdown on the horizon than investors expect. This could spook the market and trigger a selloff.
“Only thing that can stop Santa Claus rally is dovish Fed cut causing a selloff,” Hartnett wrote in a note.
Currently, traders are all-in on the idea of rate cuts. Bets on a cut at the December 10 meeting have soared to over 90%, and the market has fully priced in three cuts by September 2026. This confidence has fueled the recent stock market surge.
While seasonal trends usually favor a strong finish to the year, the market still faces risks from delayed jobs and inflation reports due out later this month.
Hartnett’s team suggests investors prepare for this uncertainty by buying “inexpensive” mid-cap stocks. They also see good opportunities in sectors tied to the economic cycle, like homebuilders, retailers, and transportation stocks.
