Bank of America's chief investment strategist Michael Hartnett has cautioned that despite the current phase of extreme bullish sentiment, contrarian investors are bracing for a sudden shift in market mood and are prepared to rotate their portfolios into "risk-off" positioning at any moment.

In the latest edition of the Flow Show report, Hartnett identified two pivotal upcoming catalysts that could spark this potential transformation: a possible de-escalation in the US-Iran conflict, and the impending US midterm elections. Any sudden geopolitical cooling or an unexpected shift in political power could swiftly shatter the fragile consensus that has been propping up the leaderless rally in risk assets.

The report noted that capital flows already reflect investors moving to hedge against fiat currency depreciation, with defensive assets experiencing significant inflows. The latest data shows that gold and cryptocurrencies collectively attracted more than $10 billion in a single week, while US equities witnessed notable outflows—underscoring the hidden currents beneath the surface-level prosperity and the defensive psychology taking hold among market participants.

Meanwhile, the bond market is competing for dominance in global asset pricing. Hartnett believes that whether policymakers can successfully suppress long-term Treasury yields is not just about the financing environment for AI capital expenditure—it is the absolute linchpin determining whether the current risk appetite in equities can be sustained.

Two reversal signals: the contrarian waiting list

Hartnett clearly outlined in the report the two "reversal risk" opportunities that contrarian investors are patiently awaiting.

First, a détente in the US-Iran situation and the final leg down in oil prices. If the US-Iran conflict sees substantive easing, oil prices would face one last round of downward pressure, at which point optimism around earnings per share expectations could peak, creating an entry window for shorting risk assets.

Second, the outcome of the US midterm elections. Hartnett explicitly stated that if Republicans lose Senate seats or the Texas governorship, it would deliver a negative shock to markets. His reasoning is as follows: voters are using their ballots to signal that affordability and inflation control carry greater political priority than tax cuts, deregulation, or pushing stock prices higher—which would fundamentally shake the policy foundation underpinning the current market consensus.

Until these two signals are triggered, Hartnett expects the market to continue its grinding-higher pattern without a leading sector, while contrarian investors remain on high alert, ready to switch into defensive mode at any time.

Fund flows and sentiment indicators: defensive assets seeing a scramble

Amid recent market turbulence, fund flows have exhibited a pronounced "anti-depreciation" character.

According to the Bank of America report, capital is exiting traditional risk assets on a large scale and pouring into alternative defensive havens.

Specifically, gold recorded $7.3 billion in inflows, while cryptocurrencies saw $3.2 billion in inflows—both representing the largest weekly figures since October 2025.

In stark contrast, US equities experienced $4.4 billion in outflows, the first in five weeks, and high-yield bonds also saw $700 million in redemptions. Although technology and materials sectors still attracted inflows, the overall flow picture has taken on a defensive tilt.

Additionally, the bank's Bull & Bear Indicator climbed further to 9.7 last week, essentially touching its all-time high. Hartnett attributes this extreme bullish reading to broadening global equity index participation, alongside hedge funds adding to gold longs and VIX shorts. Even though the S&P 500 has edged higher since triggering a "sell signal" on May 26, extreme positioning has laid the groundwork for a potential pullback.

Bond market pricing power: yields become the core battleground

Michael Hartnett stated bluntly in the report that currently "bonds trade information, stocks trade narratives." Within the AI investment boom, AI-related bonds are being viewed as a leading indicator.

The report notes that underperformance of AI spenders (MAGS) and AI builders (SOX) relative to AI adopters will only end when the 30-year Treasury yield falls below 5%—a target that appears difficult to achieve in the near term.

Hartnett believes that new Federal Reserve Chair Warsh's speech at Jackson Hole attempted to strike a balance between inflation and the yield curve. Although the 2-year to 30-year yield curve flattened significantly and the dollar rebounded following the speech, broader risk appetite failed to recover as expected, and Treasury yields even broke through the key intervention level of 4.7%.

Michael Hartnett argues that the policy combination of Bessent and Warsh must prevent US Treasury yields from climbing further; otherwise, long-duration trades will face enormous pressure.

Policy and positioning: central bank pivot collides with the "no-landing" consensus

From a positioning standpoint, investors are currently immersed in a perfect consensus of "no macro landing, no Fed rate hikes, no AI capex cuts, and no Democratic sweep." Asset allocation reflects long equities, long investment-grade bonds, and short government bonds and the dollar.

However, to hedge against the risk of this highly uniform consensus, Michael Hartnett maintains long positions in gold and global natural resources and other commodities.

On the policy front, global central banks are quietly changing course. The report indicates that over the past three months, global central banks have executed 13 rate hikes, exceeding the 12 rate cuts during the same period, with Bank of America projecting a year-end tally of 17 hikes versus 4 cuts.

Hartnett believes that central bank rate hikes help support the US Treasury's bond and FX intervention efforts to suppress long-end yields—which is crucial both for financing the AI capex boom and for preventing consumers from raising precautionary savings out of concern over the $40 trillion national debt. Notably, the Treasury's buyback program is scheduled to conclude on November 4, exactly one day after the US midterm elections.

On the political front, Trump's economic approval rating (35%) and inflation approval rating (28%) have both slipped again. Hartnett points out that quickly ending the US-Iran conflict is the most straightforward path to boosting approval numbers—which is precisely the core logic behind contrarian investors' close watch on the Iran situation.