BofA: Defensive stocks also showing signs of a bubble as US and European earnings options diverge in pricing

Why is the shift into defensive stocks also putting BofA on alert?

After the AI trade weakened, money shifted heavily into US healthcare and consumer staples stocks, and bubble-risk indicators for both sectors are approaching the risk zone. BofA says similar patterns appeared during the internet bubble in the late 90s of the 20th century and during the post-pandemic rally.
The indicator combines price returns, volatility, momentum and price fragility, with values ranging from 0 to 1. BofA uses readings above 0.8 as a reference threshold for higher risk. It measures price movements and should be assessed alongside fundamentals and positioning.
Compared with the peak of the internet bubble, high indicator readings are still concentrated in fewer stocks today: as of 23 October, 15 S&P 500 constituents had readings above 0.8, versus roughly 50 to 100 at the hottest point back then.

On 22 October, the Nasdaq fell nearly 3%, while the US 10-year yield fell by more than 16 basis points. BofA interprets this simultaneous decline in stocks and bond yields as a growth shock: if AI-related weakness persists, interest rates could fall further.
Based on this relationship, BofA continues to favor Nasdaq 100 lookback put options conditional on a decline in 10-year rates as a longer-term hedge against AI risk. The bank believes that, although rates have already edged lower, the structure remains attractively priced relative to other long-term hedges.
Another scenario is a rebound in risk appetite. BofA believes sentiment could turn optimistic after events including tech giants’ earnings, the Federal Reserve’s October rate-setting meeting and the midterm elections have passed. In that scenario, call spreads offer a way to participate in potential gains with limited risk.

BofA compares the additional volatility implied by options for earnings events with the actual volatility that follows. Although US earnings-option pricing has risen, actual volatility has risen more, particularly for mega-cap companies, leading the bank to see continued relative value in US single-stock earnings options.
Among the 50 largest S&P 500 companies by market capitalization, more than half recently saw post-earnings share-price moves exceed the range previously implied by options. By market capitalization, those companies accounted for about two-thirds, a share at the historical 98th percentile.
The opposite is true in Europe: the additional earnings volatility implied for Euro Stoxx 50 constituents is at the historical 94th percentile, but recently only about one-third of companies saw actual moves exceed the range previously anticipated by options. BofA therefore considers European earnings volatility expensive.

BofA’s global financial stress indicator rose from 0.09 on 16 October to 0.20 on the 23th, its highest since 7 April and at the 66th percentile since 2000.
Commodities and equities were the asset classes with the highest stress and the main ones in which stress rose last week. The weekly increase in crude oil implied-volatility stress was at the 93th percentile since 2000. By contrast, stress in credit, foreign exchange and interest rates remained below their respective long-term medians.