Investors are pouring money into U.S. equities as markets hover near record highs, but Bank of America strategists believe the rally may have become too crowded. That could make defensive equity ETFs an attractive way to stay invested while reducing exposure to the market’s riskier corners.
BofA’s Bull & Bear Indicator rose to 9.7 from 9.4, its highest level since 2021, according to Bloomberg. Strategists led by Michael Hartnett cited broadening equity markets, strong high-yield inflows and tighter credit spreads as evidence of increasingly bullish sentiment. Their message: “Retreat/Rotate,” rather than “Reload.”
The warning is notable because U.S. equities have continued to attract substantial capital. BofA, citing EPFR Global data, said U.S. equities drew $9.6 billion in the week through Aug 5. Separately, U.S.-listed ETFs collected $191.3 billion in July, taking 2026 inflows toward $1.3 trillion, according to ETF.com. U.S. equity ETFs accounted for roughly $75 billion of July’s inflows.
That backdrop could strengthen the case for sectors that traditionally hold up better when investors become more cautious.
XLP: Consumer Staples with Strong Momentum
The State Street Consumer Staples Select Sector SPDR ETF (NYSE:XLP) offers exposure to companies selling products consumers continue to buy regardless of economic conditions. Its holdings include Walmart Inc (NASDAQ:WMT), Costco Wholesale Corp (NASDAQ:COST), Procter & Gamble Co (NYSE:PG) and Coca-Cola Co (NYSE:KO).
XLP has also participated in the 2026 rally. The ETF was up approximately 10% year to date, versus about 13% for the S&P 500. More importantly for BofA’s rotation thesis, XLP has started attracting fresh capital: the fund recorded approximately $582 million of net inflows in July, clocking inflows for the first time since February, according to ETFDb.
That suggests investors are not simply using staples as a defensive shelter after a selloff; some are already positioning for the sector to outperform if market enthusiasm cools.
XLU: Defensive Sector with an AI Catalyst
The State Street Utilities Select Sector SPDR ETF (NYSE:XLU) offers another potential rotation target. Utilities are traditionally considered defensive because electricity, gas and water demand is relatively stable across economic cycles.
XLU generated more than $478 million of net inflows in July.
Utilities have an additional 2026 catalyst: AI-driven data-center electricity demand. XLU’s portfolio is dominated by electric utilities, which represents about 65.6% of the fund.
That gives XLU an unusual combination of characteristics: defensive exposure if economic growth weakens, plus potential structural demand from the massive power requirements of AI infrastructure.
Defensive Rotation, Not a Market Exit
BofA’s warning does not necessarily call for abandoning stocks. Instead, XLP and XLU offer investors a way to rotate within equities as valuations, AI enthusiasm and expectations for Federal Reserve policy become increasingly important.
With U.S. equity inflows running at extraordinary levels and BofA’s sentiment gauge flashing its strongest warning since 2021, defensive sectors could become more attractive if investors decide that protecting gains is more important than chasing the next leg of the AI rally.
Photo: Shutterstock
