Bank of America's chief investment strategist Michael Hartnett is bearish on 2022, sees a rates shock

Published Mon, Nov 22 20212:05 PM EST

Tighter monetary policy will lead to higher interest rates and more volatility, making stocks a tough bet in 2022, according to Bank of America chief investment strategist Michael Hartnett. Hartnett wrote in a look-ahead to clients that inflation will push rates higher, with a potential risk that the Federal Reserve will keep tightening policy to ward off higher prices, even if Wall Street starts to suffer. This would follow a booming year for stocks and multiple other assets. "We know asset price sensitivity to central bank liquidity has been extremely high in past decade, and a global tapering has begun," he wrote in the Sunday note. Hartnett added that while corporate profits have been soaring, a retreat from central banks will start putting pressure in earnings per share. "We are therefore bearish and believe capital preservation will grow as the theme in the year ahead," he said. In a previous note, Hartnett said tighter policy from the Fed would hit a succession of asset classes, with credit and cryptocurrencies such as bitcoin the "next dominoes to fall." "The scenario is that the expectation for financial conditions tightening, which is beginning to be seen in emerging market currencies and bonds, creeps into crypto and credit. The equity market is always the last to acknowledge it," Hartnett said in an interview Friday. "That would happen in the first half of next year." "So where the risks for the second half of next year are, is that the Fed does aggressively tighten in the face of market volatility," he added. "Nobody believes the Fed will do that." In the face of that kind of scenario playing out, Hartnett expects a "rates shock" in 2022 to follow the "inflation shock" of 2021. The result will be "low/negative [and] volatile asset returns" for the year. He recommends long trades on the U.S. dollar, volatility, quality defensive stocks including consumer staples, telecommunications and big pharmaceutical companies. He also recommends oil and energy and real assets, and will be betting against copper and semiconductors. For contrarian trades, he sees gold, emerging markets, commercial real estate, China credit, small-cap value stocks and "income streams in the commodity markets" due to "dollar debasement. He also likes betting against the Nasdaq, with the tech-rich index exposed to higher rates and more regulation coming out of Washington. On the latter point, Hartnett warns that the biggest "fat-tail" risk for the year ahead is "the mother-of-all-bubbles in crypto & tech." Though Hartnett is taking a dim view of stocks, the BofA economic team expects "robust GDP" growth in the U.S. and around the world, though China could be an "outlier" with a somewhat slower pace. From an investing standpoint, however, the equity team sees a "backdrop … similar to the early stagflation of the late-60s, early 70s … [a] period of inflation & interest rates breaking higher from secular low/stable trading ranges on back of high budget deficits." The bull case is a stock market that could rise if the Fed makes it clear it will keep rates low regardless of inflation, and that the central bank deems Wall Street too big to fail. The prevalent bear case is the opposite — a Fed that pushes rates higher even if there is a market correction, while bond vigilantes return as Washington continues to run up reed ink. "More extreme downside risks include a crypto-derivatives crash, geopolitical events related to China & Taiwan, and that a receding liquidity wave exposes credit-events to the detriment of private & public equity," Hartnett wrote.

NEW YORK - The Bank of America trading post on the floor of the New York Stock Exchange on August 4, 2011.

STAN HONDA/AFP via Getty Images

Tighter monetary policy will lead to higher interest rates and more volatility, making stocks a tough bet in 2022, according to Bank of America chief investment strategist Michael Hartnett.