BofA believes that the combination of Trump's 2.0 policies and the AI revolution has created a new phenomenon that has never been seen since the roaring 2020s. However, while this combination may promote prosperity, it will also amplify the "right tail risks" of 2025, possibly even more than many expect.
As 2024 is approaching its end, Bank of America has deeply analyzed the market dynamics of this year and issued a warning for the coming year.
Bank of America believes that 2024 will be a bumper year for the US stock market, and the prosperity will continue into next year. However, considering the current combination of Trump 2.0 policies and the AI revolution will lead to an accumulation of risks, the expected PE of the S&P 500 Index exceeding 25 indicating overvaluation, and the VIX Index fluctuations showcasing market vulnerability, a bubble in 2025 may burst and be difficult to avoid.
The momentum of prosperity continues, while risks may accumulate or exceed expectations.
Bank of America believes that the US stock market faces 'right-tail risks,' which may be larger than many anticipate.
In 2024, there is a clear upward trend in the US stock market, with the S&P 500 Index achieving over 20% growth for the second consecutive year, led primarily by Large Cap Technology stocks. Bank of America believes that the policies implemented after Trump took office will fuel the post-election stock market boom, which also means that this prosperity will extend into 2025.
It is worth noting that during the previous administrations of Presidents Reagan and Coolidge, the implementation of laissez-faire economic policies, deregulation, and tax cuts once propelled asset prices to rapidly rise. The technological booms of the 1920s and 1990s similarly created this phenomenon. The year 2025 achieves a rare overlap of both, with Trump 2.0 policies colliding with the AI revolution, creating a new scene that has not been seen since the roaring 1920s.
However, Bank of America pointed out that while this combination will promote prosperity, it will also amplify the "right tail risk" in 2025, which may be greater than many expect.
Moreover, after the US elections, the trend of Small Cap stocks emerging did not last, as Large Cap stocks regained their "dominance". Bank of America believes that factors such as AI prosperity and high interest rates may help US Large Cap Technology stocks continue to outperform the market, but this also poses an underestimated right tail risk:
"Because many investors either cannot achieve market weight in Large Cap Technology stocks or feel nervous about the excessive optimism and valuations in this sector. Holding US stocks, Large Cap stocks, or underperformance in Technology stocks has been a painful situation for years."
Momentum is too strong, valuations are too high, and a crash is inevitable.
Bank of America believes that the expected PE of the S&P 500 Index has exceeded 25, with valuations too high, making a crash inevitable.
Bank of America pointed out that the S&P 500 Index is expected to rise more than 20% for two consecutive years, and the upward momentum seems to remain strong. However, recently, the expected PE of the S&P 500 Index has exceeded 25, at a historical high. Historical Data also indicates that such prosperity is often followed by a recession.
Bank of America warns that history shows it may be too late to avoid a recession now. Furthermore, as this decline shows signs of both a crash and a bubble burst, Bank of America reminds that while hedging, one should prepare for any possible scenario.
The market remains fragile, the impact has already come.
Bank of America believes that the VIX Index impact on August 5 of this year is a dangerous signal, indicating that the foundations of market vulnerability still exist.
Bank of America Analysts emphasize that the market has become more fragile over the past few years, manifested by prolonged calm followed by more severe fluctuations. This vulnerability is driven by investors flooding into a limited capacity.momentum trading,, and then facing a liquidity exhaustion feedback loop when they exit.
Especially, the VIX Index has shown dangerous signs, experiencing an impact on August 5 of this year when, despite the S&P Futures only dropping 4.4%, the VIX Index surged 42 points before the market opened, marking the largest increase in its 34-year history; moreover, VIX Options information also shows that Hold Positions risk still exists, with the degree of disconnection between the VIX Index and stock market movements reaching its highest level since February 2018.
Historically, large volatility impacts like those in February 2018 and March 2020 are usually liquidation events, occurring several years apart each time. However, this August seems not to have eradicated VIX Options positions, which also means the next pressure event involving the VIX ecosystem may be imminent in the coming years.
Bank of America stated that the market turmoil on August 5 serves as a stark reminder that the foundations of market fragility still exist, and liquidity may quickly disappear when most needed. The shock may have already arrived, which is also the main "left-tail risk" for 2025.
