5 reasons the S&P 500 could slump for the rest of 2021 despite strong profit growth and economic optimism, according to Bank of America

worried trader

US corporations have been issuing positive guidance on profits and economists continue to upgrade their GDP estimates as optimism on the economic recovery accelerates. But this isn’t necessarily a good sign for the stock market, Bank of America said.

A team of BofA strategists recently raised their 2021 earnings estimate to $185, but maintained their expectations for relatively flat stock gains for this year. The firm has a year-end price target of 3800 for the S&P 500, a nearly 8% pullback from current levels.

Here are five reasons why investors should “curb their enthusiasm” and brace for flat returns from stocks in 2021, according to Bank of America.

1) Sentiment

Wall Street bullishness is rising to near-euphoric levels, as seen by BofA’s contrarian sell-side indicator. Their indicator is less than a point away from indicating overextended optimism on Wall Street and flashing a sell signal.

2) Valuation

The current valuation of the S&P 500 indicates “paltry” returns over the next decade, said the strategists.

“Valuation is almost all that matters over the long-term,” BofA said. “With the increase in valuations in April, this framework yields 10-yr price returns of just 2%/year (versus 5% in Nov., and 10% 10 years ago).”

3) Outsized Returns

The S&P 500 posted 12 month returns of over 54% through March 2021, which was the third highest 12-month return on record since 1936. It was also 2.3 standard deviations above average. BofA data shows that losses have historically occurred for the next 12 months when the S&P 500 makes a 2+ standard deviation move like this.

4) Overshoot in fair value

One of BofA’s fair value models forecasts the S&P 500 to hit 3635 by year-end. “This is based on our 2022 cyclically-adjusted earnings forecast of $173 and our equity risk premium (ERP) forecast of 425bp by year-end (vs. 398bp today) as 2H shifts to concerns about peak earnings and peak stimulus,” said the firm.

5) Elevated Risk Appetite

A contrarian signal that measures the return on investments given the risk an investor takes has dropped to dangerously low levels, BofA added. In the two most recent instances that equity risk premium dropped below 400 basis points, the S&P 500 posted 10% and 20% peak to trough declines.

Against this backdrop, the strategists recommend investors buy cyclical stocks, small-caps over large-caps, and stocks that hinge on strong GDP and an expansion in capital expenditures.

Read the original article on Business Insider

A worryingly large number of US stocks are expensive, crowded, and pose a downside risk to the S&P 500, says Bank of America

Traders and financial professionals work ahead of the closing bell on the floor of the New York Stock Exchange (NYSE) from Getty Images
  • Mega-cap growth stocks are overcrowded, expensive, and dampen the outlook for the S&P 500 in 2021, BofA said. 
  • A team of strategists said in a Friday note that bullish sentiment and high valuations indicate risk in the stock market. 
  • With the S&P 500 set for flat returns this year, BofA favors value stocks, small-caps, and cyclicals.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

Mega-cap growth stocks are vulnerable to a downturn that could weigh on the whole S&P 500 index, according to Bank of America.

A team of strategists led by Savita Subramanian said in a Friday note that large-capitalization growth stocks – assets which make up a large chunk of the US market – are expensive and crowded, even when accounting for historically low interest rates. 

Stocks are forward-looking instruments, and investors attribute the record rally in stocks during the COVID-19 pandemic to the fact that equities were anticipating future growth. However, Bank of America said that some stocks, particularly those within large-cap growth “overshot,” future growth estimates.

Now, “bullish sentiment, lofty valuations, massive dispersion between rich and cheap stocks, and no rewards for EPS beats all indicate risk,” the strategists said.

All of this has led Bank of America to a 2021 year-end price target of 3,800 for the S&P 500, a slight decline from current levels. 

This doesn’t imply that 2021 won’t be a positive year for the economy, however. With the vaccine rollout underway, a large fiscal stimulus about to be passed, and impressive earnings beats, BofA economists are forecasting 6.5% US GDP growth this year.

The strategists emphasized that the S&P 500 isn’t a pure reflection of the economy-it’s more global, more levered to capex than consumption, has operating leverage, and has more exposure to technology, media, and telecommunications than the broader economy. Therefore, while the S&P 500 will remain flat for this year, profits and economic growth will be strong.

Against this backdrop, the strategists reiterated their recommendation for cyclical and small-cap stocks. They also said value stocks look attractive.

Read more: A CIO who earned up to 90% per trade during last year’s crash is now warning of a potential 20% crash in the S&P 500 by the end of March as 10-year Treasury yields continue to rise

Read the original article on Business Insider