Don't fear the 'big, bad' central banker

Reuters / David StubbsFed Chair Janet Yellen and ECB President Mario Draghi share a chuckle.Don't fear the big, bad central banker.

That's the advice being offered by Bank of America Merrill Lynch (BAML), which sees investor anxiety creeping higher amid tightening monetary conditions, but doesn't necessarily agree with it.

That nervousness has manifested itself in both equity and bond markets worldwide, which tumbled on Thursday amid renewed trepidation over central bank hawkishness.

And while BAML understands the worry - after all, the unwinding of unconventional stimulus measures puts the market in uncharted territory - the firm still thinks there's way too much going for the market right now. Most notably economic growth that will translate to more corporate profits.

"Who's afraid of the big, bad central banker?" the equity strategy team at BAML wrote in a client note. "We doubt some central bankers huffing and puffing about tighter policy will bring markets crashing down, unless they start to hurt growth. We think investors should buy any pullback in equity markets with stabilising bond yields the likely necessary pre-condition for a renewed rally."

Investors were indeed in the buying spirit on Friday following a jobs report that saw nonfarm payrolls exceed expectations, while average hourly earnings also ticked higher.

It's this type of robust growth that BAML sees underpinning further market gains, particularly in stocks, which rely heavily on profit expansion to move higher.

Bank of America Merrill LynchInvestors quickly overcame weakness resulting from the 2013 taper tantrum.Any skeptics would be well-served to revisit the so-called "taper tantrum" of 2013, which saw bond yields spike 140 basis points and the S&P 500 fall more than 5% in response to a slowing of Federal Reserve asset purchases. While the short-term weakness was certainly jarring, both markets bounced back with aplomb.

The groundwork for a similar recovery is already in place, with the S&P 500 expected to grow earnings by 7.4% in the second quarter, which would mark the fourth straight period of profit expansion. The benchmark's 14% earnings growth in the first quarter was the best in more than five years, according to data compiled by Bloomberg.

Bank of America Merrill LynchEarnings have continued to grow following the end of Fed quantitative easing.

Further, while stock market nervousness currently seems elevated, with the CBOE Volatility Index rising 20% over the past week, the measure is actually low relative to recent history. The so-called VIX still sits 35% below its average for the eight-year bull market.

That's not to say it will be smooth sailing from here on out. BAML acknowledges that unforeseen geopolitical developments can cause short-term anxiety. But that doesn't change the firm's longer-term outlook.

It will be a "choppy market until bond markets stabilize, but then buy the dip," said BAML. "Central bankers are unlikely to bring markets crashing down."

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