'Trades of the unexpected.' How to hedge against the least likely outcomes in 2024, according to Bank of America

By Barbara Kollmeyer

Equities had the second-largest inflow of the year in the latest week

Investors are convinced they've got the Federal Reserve figured out -- no more interest rate hikes in this cycle -- and have been pouring money into stocks.

Equities recorded the second largest inflow in 2023 of $23.5 billion and U.S. large-caps drew the most investor money -- $23.7 billion -- since February 2022 in the week ending Nov. 15, according to strategists at Bank of America. And Treasurys saw the first outflow since February of $1 billion.

So some certainty in a year that has brought challenges aplenty? The past year has made 2022 look easy, with its "bear in bull's clothing or "bull in bear's clothing" market, a team of Bank of America strategists led by Michael Hartnett told clients in a note on Friday.

What have investors endured? A U.S. government budget deficit at 9% of GDP, a peak-to-trough loss of 50% for the U.S. 10-year Treasury note BX:TMUBMUSD10Y, oil (CL.1) in a bear market (as of Thursday), the Magnificent Seven technology stocks representing more than 30% of S&P 500 SPX market capitalization, and bank stocks at an 80-year low for starters, they say.

And headed into 2024, they are clearly hoping for an easier time, with "soft landing" expectations, or an economy that slows just enough to satisfy the Federal Reserve, but not enough to tilt into a recession.

Hartnett and Co. note that 80% of fund managers in Bank of America's November survey are expecting lower interest rates, 82% lower inflation and 61% lower bond yields.

Read: Stock-market investors are convinced the Fed is finished with rate hikes. Why it isn't a done deal.

But Hartnett cautions that the 10-year Treasury yield could make 2024 difficult. While a yield of 4% to 5% means easier financial conditions and "risk on" for markets, one that drops to the 3% to 4% range would bring on recession talk and a bearish risk for markets, he said.

He and his team also want investors to think about some contrarian possibilities for 2024.

The below table of "Twelve Angry Trades" lays out the thinking of those fund managers for the year ahead. For example, just 6% believe inflation could shoot higher and hardly any of them expect the Magnificent Seven tech stocks will disappoint investors next year:

Their next table offers some ideas on how to play those unexpected themes, "hedging opportunities and trades of the unexpected in 2024." So for example, if you're the contrarian trader who expects the current geopolitical storm that includes wars in the Middle East and Europe will right itself by 2024, then bet on falling oil prices:

Read: Goldman Sachs says OPEC will probably keep a floor on oil prices at around $80 for next year.

Or maybe if you're among the few that expect higher interest rates, it's time to get out of investments that are heavy on leverage. But for the contrarians expecting leverage to outperform, then bullish positions on real-estate investment trusts would be the play, say the strategists.

Hartnett and Co. say investors should also remember that 2024 is a major election year in countries that account for 80% of the world's market capitalization, 60% of the world gross domestic product, 40% of the world's population such as Taiwan, Indonesia, Russia, Korea, India, South Africa, the EU, Mexico , the U.S. and the U.K.

Also read: Bad news is good news for stocks right now -- but not for long, says this strategist

-Barbara Kollmeyer

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11-17-23 0941ET

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