5 defensive trades to make if stagflation and hard-landing fears cause a stock sell-off, BofA says

• Stocks are vulnerable to a stagflation or hard landing rebound, says Bank of America's Michael Hartnett.
• Investor optimism is currently at a more than two-high high, but Hartnett says sentiment is overextended.

Stock markets face downturn risk if stagflation or recession anxiety re-materializes, Bank of America's top global strategist Michael Hartnett wrote on Tuesday.

"Sentiment not at 'close-eyes-and-sell' levels but risk assets vulnerable to more evidence of stagflation," he noted in the bank's latest Global Fund Manager Survey.

The scenario, where inflation bounds up amid cooling growth, is feared by Wall Street, given that it typically means higher interest rates that can buckle soft landing prospects.

Although outlooks have since calmed, stagflation seemed like a growing possibility last month, when estimate-beating inflation data eclipsed shallow first-quarter GDP. Now, Tuesday's producer price index report is again showing hotter-than-expected inflation, bringing little comfort for those concerned.

To hedge against a stagflation or hard-landing outcome, Hartnett outlined five trades that markets will favor:

1. Cash over stocks
2. REITs over commodities
3. UK and China over Europe and Japan
4. Utilities over tech
5. Discretionary over healthcare

BofA's survey showed that investor optimism is at its highest since late 2021, driven by confidence that the Federal Reserve will cut interest rates in the second half of 2024. 78% of investors expect at least two cuts from the bank in the next 12 months, while 82% anticipate the first cut to occur in the later half of this year. Hartnett's commentary implies that the overextended nature of these metrics is why the stock rally is so vulnerable right now.

Further, macro pessimism has jumped, with 9% of investors expecting a weaker global economy in the next year. Stagflation may have some part to play, as inflation remains the leading tail risk, while fears of an "economic hard landing" grew stronger.