Bank of America's Hartnett discusses "first-quarter strategy": Trump aims to "curb inflation, lower interest rates" for re-election, investors should "go long on economic prosperity, short on AI bubble"

In the first Flow Show report of the New Year, Bank of America strategist Michael Hartnett stated that although BofA's "Bull Bear Indicator" had reached a high of 9.0, signaling a "sell" signal, and the market typically should take profits at this point, the situation this time is different. The Trump administration is working hard to lower inflation and reduce funding costs in order to win the midterm elections, forcing investors to adopt a strategy of "going long on economic prosperity (Long Boom) and short on asset bubbles (Short Bubble)". Hartnett believes that the correct strategy for the first quarter of 2026 is "rotation rather than retreat". Despite outflows from tech stocks, the breadth of global stock markets is very strong (98% of country indices above the 200-day moving average), and Bank of America's global fund manager survey (FMS) shows cash positions at a record low of 3.3%. In this background, investors should reduce their exposure to overheated AI concepts in 2025 (especially AI derivatives and bonds related to high capital spending) and instead increase their holdings in value cyclicals. In short, it is a "prosperity without a bond collapse," and market breadth will outperform concentration. For the core allocation in 2026, Hartnett proposes the framework of "Long BIG, Trading MID": long bonds, international stocks, and gold in the long term; and mid-cap stocks for trading strategy, while shorting investment-grade bonds and the U.S. dollar. Political necessity: Trump's "intervention" in prices for midterm elections The current macro backdrop is deeply driven by domestic politics in the United States. Hartnett points out that Trump's approval rating is low (only 43%, with economic support at 41% and even lower support at 36% for handling inflation). In order to gain an advantage in the midterm elections, the Trump administration must lower inflation. This explains why current monetary policy aims to lower funding costs (through the Federal Reserve's purchase of Treasury bonds through QE and Trump's QE targeting MBS), geopolitical policy aims to lower oil prices, trade policy is shifting towards reducing tariffs, and industrial policy is intervening in healthcare, housing, insurance, and electricity prices. This policy shift has led investors to bet on "economic prosperity" and a "risk parity bull market," and to increase exposure to market breadth. Abnormal capital flows: record cash inflows and "sell signals" Capital flow data shows extreme market sentiment. In the first week of 2026, money market funds saw a staggering $148.5 billion inflow, the third largest single-week inflow in history. At the same time, Bank of America's private wealth clients (with assets under management of $4.3 trillion) show that equities account for as high as 64.2%, bonds 17.6%, and cash 11%. It is worth noting that the "Mag 7" stocks account for 17% of their assets under management. However, over the past four weeks, private clients have been buying high-dividend stocks, municipal bonds, and REITs while selling bank loans, investment-grade bonds, and tech stocks. In addition, U.S. household equity wealth surged by about $9 trillion in 2025, continuing the trend of a $9 trillion increase in 2024 and an $8 trillion increase in 2023. Bank of America's Bull Bear Indicator reached a "extremely bullish" level of 9.0 on December 31, triggering a reverse sell signal, but this was offset by the strong breadth of global stock markets and hedge funds increasing their S&P 500 long positions through futures. Q1 Trading Guide: buy cyclicals, short AI bubble periphery Based on the above background, Hartnett provides clear asset allocation recommendations for the first quarter. The current rotation strategy should be further deepened: Increase exposure to value cyclical stocks: Focus on banks, real estate, commodities, industrials, and mid-cap stocks. Maintain but no longer increase holdings in the "Mag 7": These defensive large tech stocks have actually declined since October 29 and the November elections. Trim bubble assets: Cut back on 2025 AI trades that belong to "second derivatives" or are unable to afford capital spending, such as shorting bonds of AI hyperscaler companies. Contrarian investment logic: why bonds and gold are key In a recent London roadshow, clients believed that "going long on bonds" was the most contrarian view. In response, Hartnett's counter-logic is very clear: Debt pressures force QE: US Treasury bonds will increase by $1 trillion in the next 100 days. To maintain buying interest in the bond market and prevent the market from testing the new Fed Chair (historical data shows that within 3 months after 7 nominations since 1970, yields have risen), the Trump administration must implement quantitative easing (QE). Dual constraints of employment and inflation: Trump needs to lower the CPI to win votes, while the Fed needs to lower rates to prevent the unemployment rate from rising above 5% (youth unemployment is already at 9%). In terms of geopolitics, the market is chasing hedge assets. Greenland Bank's stock price has risen by 33% in 4 days, reflecting speculation in the market about the possibility of the U.S. "acquiring" Greenland. Hartnett points out that investors are positioning themselves in advance for energy and commodity reserves (Venezuela holds 17% of the world's proven oil reserves, while the Arctic holds 13% of undiscovered oil and 30% of natural gas). Historical data shows that since 1939, the best-performing asset in the 6 months after the outbreak of war is gold (+18.9%), followed by copper (+6.7%) and stocks (+4.9%). With the possibility of the U.S. shifting from "exceptionalism" to "expansionism" and the Fed and Trump attempting to dilute debt through currency depreciation, this constitutes the best reason to go long on gold and short on the U.S. dollar. For international stock markets, Hartnett believes that the consumer sectors in the UK and China have the best upside potential. This article is reprinted from "Wall Street See News", author: Xu Chao; GMTEight Editor: Huang Xiaodong.