BCA Warns the Stock Market Rally Is Losing Momentum
The equity bull market may be approaching its final stages, according to BCA Research’s third-quarter strategy outlook.
The investment research firm warned that global stocks could eventually fall between 30% and 50% if the artificial intelligence earnings boom turns into a bust.
BCA has already reduced its exposure to equities after one of its main market-timing indicators weakened.
BCA Downgrades Its Equity Outlook
BCA’s MacroQuant equity z-score fell below the -1 threshold on June 12.
The model uses a range of economic and financial indicators to assess market timing and investor risk.
Following the decline, BCA downgraded equities from neutral to a modest underweight position over both three-month and 12-month periods.
However, the firm has not yet adopted a strongly bearish outlook.
BCA said it would move toward a more defensive strategy if its market indicators weaken further.
For now, the firm recommends balancing its lower equity allocation with a slight overweight position in cash and a neutral allocation to bonds.
AI Earnings Bubble Raises Market Risks
BCA’s main concern is what it describes as an earnings bubble in artificial intelligence stocks.
Unlike traditional market bubbles, which are often driven by extreme valuations, BCA believes this cycle is partly supported by accounting practices.
When technology companies purchase chips from suppliers such as Nvidia or Micron, they often record the purchases as long-term assets rather than immediate expenses.
This accounting treatment can increase reported earnings without producing an equivalent rise in cash flow.
As a result, corporate profit margins may appear stronger than the underlying financial performance suggests.
S&P 500 Profit Margins Have Expanded
Since 2019, forward profit margins for the S&P 500 have risen by 3.8 percentage points.
The increase has been even larger in the information technology sector, where margins have climbed by 11.3 percentage points.
BCA estimates that the S&P 500 would currently trade at around 26.5 times forward earnings if profit margins had remained unchanged.
Instead, the index trades at approximately 20 times forward earnings.
This suggests that unusually high margins may be making equity valuations appear less expensive than they really are.
AI Boom May Be Near Its Final Stages
BCA strategists led by Peter Berezin compared the AI boom with a baseball game entering its final innings.
They estimated that the cycle may already be in the seventh or eighth inning.
This stage can still produce strong gains and high investor excitement. However, it may also indicate that the market is moving closer to the end of the cycle.
BCA expects equities could decline by 30% to 50% when the AI earnings bubble eventually bursts.
Bond Yields May Remain Stable in 2026
BCA expects government bond yields to remain broadly rangebound for the rest of 2026.
The firm does not believe a recession is likely this year.
However, bonds could become more attractive if the AI boom turns into a severe downturn.
BCA believes an AI-related bust could create a major deflationary shock across the global economy.
That would likely encourage central banks to cut interest rates, which could push bond yields lower and support long-duration bonds.
The firm expects to adopt a long-duration bond position at some point during the next 12 months.
U.S. Dollar Could Strengthen in the Near Term
BCA expects the U.S. dollar to remain supported in the short term.
Interest-rate differences and positive market momentum could help the currency maintain its strength.
However, the firm is more cautious about the dollar’s longer-term outlook.
BCA estimates that the currency is trading around 16% above its fair value based on purchasing power parity.
A reversal in international investment flows into U.S. stocks could therefore place significant downward pressure on the dollar.
Asian Currencies Offer Long-Term Potential
BCA sees several East Asian currencies as attractive long-term opportunities.
These include the Japanese yen, Chinese yuan and South Korean won.
The firm believes these currencies could benefit if the dollar weakens over a longer investment horizon.
Oil Prices May Be Near a Floor
BCA believes oil prices are approaching a possible bottom.
Brent crude has fallen to around $73 per barrel after previously reaching a high of $144.
The fragile ceasefire between the United States and Iran may limit further downside because renewed tensions could quickly increase supply concerns.
However, BCA prefers metals over crude oil as a longer-term investment.
Gold Outlook Remains Positive Over Time
Gold may face short-term pressure from a stronger U.S. dollar and lower inflation expectations.
Both factors can reduce demand for the precious metal.
Despite those near-term challenges, BCA remains positive on gold over the longer term.
Continued buying by central banks could provide support, while gold still represents a relatively small share of global household wealth.
Structural supply limitations also make metals more attractive than oil in BCA’s long-term commodity outlook.
BCA Favors a More Cautious Q3 Strategy
BCA’s third-quarter strategy reflects growing concern about the sustainability of the equity rally.
The firm currently favors a modest underweight position in stocks, a slight overweight position in cash and a neutral bond allocation.
It also sees long-term opportunities in Asian currencies, metals and gold.
However, the greatest risk remains a potential collapse in AI-driven earnings expectations, which BCA believes could trigger a major correction across global equity markets.
