Bank of America’s Hartnett: The materials sector will be the next "bull market favorite"

Bank of America Securities Chief Investment Strategist Michael Hartnett highlights the materials sector in his latest report, calling it the next “bull market favorite.”

Hartnett points out that global geopolitical competition for resources, the AI capital expenditure boom, surging defense spending, and the US housing shortage are collectively driving the materials sector into a long-term upward turning point.

Currently, the materials sector accounts for only 2% of the S&P 500 market cap, near a 30-year low, with significant valuation discount characteristics.

Meanwhile, he notes that US stocks have an annualized return of 20%, and gold has an annualized return of 30%. This combination has only appeared in history during periods of war, peace, bubbles, and stagflation, often signaling the accumulation of deep structural risks.

Dual Bullish Trends in Stocks and Gold Point to “Bubble Stagflation”

Hartnett states that US stocks are on track for a fourth consecutive year of double-digit gains, with an annualized return of about 20%; gold has similarly experienced a fourth year of double-digit annualized gains, at about 30%.

He notes that, the four-year consecutive double-digit rise in US stocks has only occurred historically during wartime (1942-1945), peacetime (1949-1952), and bubble periods (1995-1999);

The four-year consecutive double-digit rise in gold has only been seen during stagflation periods (1971-1974 and 1977-1980).

The simultaneous occurrence of both, Hartnett characterizes as “bubble-like war and peace overlapping stagflation.”

On the macro level, Hartnett observes that since November 2023, the pace of rate hikes by developed market central banks has first exceeded the pace of rate cuts.

Meanwhile, although emerging markets are still in a rate-cutting cycle, the extent of rate cuts has narrowed to the smallest level since August 2023.

He further points out that the NYSE Composite Index (which he views as Wall Street’s best barometer) faces technical resistance from a “double top” pattern in the coming weeks, signaling an “important sign” that central banks are rapidly shifting to a hawkish stance to respond to nominal economic prosperity.

“Bubble Bell” Strategy, Materials as the Optimal Pairing Choice

Hartnett proposes a “bubble bell” strategy framework, which involves going long on both “frenzied assets” and “disgraced assets,” with the former corresponding to current AI and chip stocks, and the latter referring to out-of-favor, oversold, and cyclically driven assets that will ultimately be boosted by the nominal GDP bubble wave.

Within this framework, Hartnett considers the materials sector the best pairing with chip frenzy, with consumer, Chinese, and UK assets also having pairing potential; bonds, which are neglected by the market, do not fit this logic.

The core logic supporting his bullish view on the materials sector includes multiple dimensions:

• Increasing competition among nations for natural resources under the global geopolitical landscape;

• AI infrastructure capital expenditure reaching $750 billion and continuing to rise;

• Global defense spending approaching $3 trillion;

• The US housing shortage exceeding 4 million units;

• And the “hidden appreciation” of the RMB exchange rate.

Technical analysis also provides support, as steel ETFs are currently testing levels near the historical highs before the 2008 financial crisis.

AI Giants’ Valuations Near Historical Bubble Peaks

For AI-related leading assets, Hartnett issues a warning: the top ten AI stocks now account for 40% of the total market cap of the S&P 500, with concentration levels approaching those of the “Beautiful 50” in the 1970s, the Japanese stock market in the 1980s, and the internet bubble peak in the 1990s.

However, they have not yet reached the extreme levels of the railway bubble in the 1880s.

Regarding how this boom or bubble might end, Hartnett cites historical patterns, indicating that a sharp rise in bond yields is a key trigger:

• The rise of 200 basis points in US Treasury yields ended the “Beautiful 50” bubble;

• The rise of 230 basis points in Japanese government bond yields burst the Japanese bubble;

• The 260 basis point increase in US Treasury yields in 1999 marked the end of the internet bubble.