The current stock market sell-off is rotational rather than toppy, and a bullish backdrop supports a summer rally, according to Bank of America

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  • The current sell-off in the stock market is rotational rather than toppy, Bank of America said in a note on Wednesday.
  • The sector rotation has been away from growth and towards cyclicals as investors position for rising interest rates and inflation.
  • But a bullish backdrop and near-oversold levels for the S&P 500 could support a rally into the summer months, BofA said.
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The 3% sell-off in the S&P 500 over the past week represents a rotational move into cyclical stocks and out of growth stocks rather than a top formation, according to a Tuesday note from Bank of America.

While there is likely more downside ahead for the stock market as it looks to find support near key technical levels, a bullish backdrop remains for equities. That bullish backdrop is built upon Dow Theory confirmation from transportation stocks, advance-decline readings, and credit markets pointing to continued easy financial conditions, according to the note.

Investors should look for the S&P 500 to find support near 4,020 and 3,950, which represents potential downside of 2% and 3% from Wednesday afternoon levels, respectively.

A move to those levels “could perhaps get US equities oversold enough to embark on a summer rally,” BofA said.

And while technology stocks aren’t working, other sectors are, including health care, financials, industrials, real estate, and utilities, BofA observed. The bank added that the Nasdaq is losing its leadership relative to the S&P 500, and the relative outperformance of growth over value is finally breaking down after years of working.

Rotation is often considered the life blood of a bull market, so the lack of narrow leadership among a handful of mega-cap stocks is actually a healthy development for the longevity of the current trend higher.

BofA believes that there is “plenty of room for leadership to run after a tactical dip,” pointing to the recent jump in cyclical sectors like financials and industrials. And the recent weakness in stocks serves as a good reminder for investors that May is historically a weak month for equity returns.

But that weakness in May can subside in the summer months as a potential rally develops, especially “if these rotations are tactical and temporary,” BofA concluded.