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

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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.

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8 reasons why fears of a stock-market bubble are overblown, according to Goldman Sachs

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Goldman Sachs said that fears of a bubble were overblown.

  • Goldman Sachs said that fears of a bubble in markets were overblown, despite a few concerning signs.
  • The analysts gave eight reasons, including lower levels of leverage and risk-taking.
  • They also said the boom in tech stocks had a firmer basis than in the dot-com bubble of the 1990s.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

With retail traders driving up stocks like GameStop, blank-check companies booming, and bitcoin soaring, many investors are worried about bubbles in financial markets.

But Goldman Sachs analysts said in a note on Monday that fears about bubbles were overblown. There are a few worrying signs, but markets now appear much safer than they were during the dot-com crash or the 2008 financial crisis, they said.

Here are the eight key reasons investors should not be overly concerned about the recent market frothiness, according to Goldman analysts including Peter Oppenheimer and Sharon Bell.

1. The stock-market rally is driven more by fundamental factors.

In bubbles such as the dot-com boom of the late 1990s, investors drove up asset prices with little rational basis, and the fear of missing out triggered buying frenzies.

The rise in stock prices over the past few years, particularly in tech, “has been impressive” but “is not nearly as extreme as the explosive rise that accrued during the late 1990s,” Goldman said.

The rally in tech firms can mostly be justified by “superior growth and fundamentals,” the note said, with earnings far outstripping the rest of the market.

2. The “equity risk premium” measure does not look worrying.

Goldman said that much of the market frothiness could be explained by record-low interest rates around the world.

The bank’s analysts pointed to a key measure of stock value, the equity risk premium, or the extra return investors get on stocks compared with holding risk-free bonds.

Goldman said that in the bubble of the late 1990s, investors were so confident about growth that they were prepared to buy stocks offering a dividend yield of 1% when they could make 6.5% holding bonds.

But record-low interest rates and better prospects today mean the equity risk premium is higher, suggesting investors are much more justified in bidding up stocks.

Read more: Cowen says buy these 10 retail stocks before a colossal wave of consumer spending sends them skyrocketing – including one expected to surge 71%

3. Market concentration has increased – but is not dangerous.

Goldman said Facebook, Apple, Amazon, Microsoft, and Google were increasingly dominant, with a market capitalization nearly three times the annual GDP of India.

But the bank’s analysts said that such a concentration “has reflected strong fundamental growth, rather than the hope, or promise, of returns far into the future.” This suggests it’s far more sustainable than in previous asset rallies.

4. A big jump in retail trading has followed years of outflows from equities.

The GameStop saga in January brought the power of retail investors to the attention of Wall Street.

Goldman said that the rise in amateur investing had been “breathtaking” and that one of its key measures of risk-taking had hit a level associated with a 10% drop in stock markets.

But the analysts said that “while flows have been significant of late, we have come from many years of outflows from risk assets like equities.”

5. Credit is cheap, but investors aren’t being overly risky.

Central-bank interest rates are at record lows, as were bond yields until recently, making borrowing very cheap.

But Goldman said that speculative bubbles are associated with banks and companies funding risky activities through debt and with a collapse in household savings, which “is not the case today.”

Banks are very strong thanks to reforms, the note said, adding that US households had accumulated about $1.5 trillion in savings during the COVID-19 pandemic.

6. Mergers and acquisitions are booming from a low base.

The excitement about special-purpose acquisition companies, or SPACs, has many investors worried about frothy markets.

“Booming M&A activity and equity issuance are reminiscent of activity rates in previous cycles,” Goldman said.

But it added that the activity did not appear excessive “when adjusted for the market capitalization of equity markets.”

7. The surge in certain sectors is driven by profitable companies.

Market bubbles are often driven by an enthusiasm for new technologies, such as the internet in the dot-com era.

Goldman said that while tech and green stocks had indeed boomed, a fall in these stocks should not lead to widespread company collapses, as most of them are profitable.

8. Stocks are rising as economies recover from a slump.

The Wall Street bank said the powerful rally in stocks from last March to September was typical of a “hope” phase of a bull-market run after an economic slump.

“This phase is generally followed by what we call the ‘growth’ phase,” when earnings pick up, it said, though there could be bumps along the way.

Read more: Hedge funds are ramping up bets against Chamath Palihapitiya’s SPACs and have already taken home $40 million this year. Here’s a detailed look at the wagers they’re making.

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Goldman Sachs says fears of a stock-market bubble are overblown for these 8 reasons

GettyImages 1158933047
Goldman said fears of a bubble are overblown

  • Goldman Sachs said fears of a bubble in markets are overblown, despite a few concerning signs.
  • The Wall Street giant’s analysts gave 8 reasons why, including lower levels of leverage and risk-taking.
  • They also said the boom in tech stocks has a firmer basis than the dotcom bubble of the 1990s.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

With retail traders driving up stocks like GameStop, blank-check companies booming, and bitcoin soaring, many investors are worried about bubbles in financial markets.

But Goldman Sachs analysts said in a note on Monday fears about bubbles are overblown. There are a few worrying signs, but markets now appear much safer than during the dotcom crash, or 2008 financial crisis, they said.

Here are the 8 key reasons investors should not be overly concerned about the recent market frothiness, according to Goldman analysts including Peter Oppenheimer and Sharon Bell.

1. The stock-market rally is driven more by fundamental factors than investor craziness

Past bubbles such as the dotcom boom of the late 1990s saw investors drive up asset prices with little rational basis, with buying frenzies triggered by the fear of missing out.

Goldman said the rise in stock prices over the last few years, particularly in tech, “has been impressive… but it is not nearly as extreme as the explosive rise that accrued during the late 1990s.”

The rally in tech firms can mostly be justified by “superior growth and fundamentals,” the note said, with earnings far outstripping the rest of the market.

2. The key ‘equity risk premium’ measure does not look worrying

Goldman said much of the market frothiness is explained by record-low interest rates around the world.

The bank’s analysts pointed to a key measure of stock value, the equity-risk premium. This is the extra return investors get on stocks compared to holding risk-free bonds.

Goldman said in the bubble of the late 1990s, investors were so confident about growth they were prepared to buy stocks offering a dividend yield of 1% when they could make 6.5% holding bonds.

But record-low interest rates and better prospects today mean the equity-risk premium is higher, suggesting investors are much more justified in bidding up stocks.

3. Market concentration has increased – but is not dangerous

Goldman said Facebook, Apple, Amazon, Microsoft and Google are increasingly dominant, with a market capitalization nearly 3 times the annual GDP of India.

But the bank’s analysts said such a concentration “has reflected strong fundamental growth, rather than the hope, or promise, of returns far into the future.” This suggests it is far more sustainable than in previous asset rallies.

4. A big jump in retail trading has followed years of outflows from equities

The GameStop saga in January brought the power of retail investors to the attention of Wall Street.

Goldman said the rise in amateur investing has indeed “been breathtaking.” And it said one of its key measures of risk-taking has hit a level associated with a 10% drop in stock markets.

Yet the analysts said: “While flows have been significant of late, we have come from many years of outflows from risk assets like equities.”

5. Credit is cheap, but investors aren’t being overly risky

Central bank interest rates are at record lows, as were bond yields until recently, making borrowing very cheap.

But Goldman said speculative bubbles are associated with banks and companies funding risky activities through debt, and a collapse in household savings, which “is not the case today.”

Banks are very strong thanks to post-crisis reforms, the note said. US households have accumulated around $1.5 trillion in savings during COVID-19, the bank said.

6. Mergers and acquisitions are booming from a low base

The mania for special-purpose acquisition companies, or SPACs, has many investors worried about frothy markets.

Goldman said: “Booming M&A activity and equity issuance are reminiscent of activity rates in previous cycles.”

But it added activity does not appear excessive “when adjusted for the market capitalization of equity markets.”

7. The surge in certain sectors is driven by profitable companies

Market bubbles are often driven by a craze for new technologies, such as the internet in the dotcom era.

Goldman said tech and green stocks have indeed boomed. But the analysts said a fall in these stocks should not lead to widespread company collapses, as most of them are profitable.

8. Stocks are rising as economies recover from a slump

The Wall Street bank said the powerful rally in stocks from March to September last year was typical of a “hope” phase of a bull-market run after an economic slump.

“This phase is generally followed by what we call the ‘growth’ phase,” they said, when earnings pick up, although there could be bumps along the way.

Read the original article on Business Insider