- The Bank of America strategist Savita Subramanian has a bleak outlook for stocks.
- She said in a recent note that data indicated the S&P 500 could fall 20% over the next 12 months.
- Many stock-valuation measures are extended by historical standards.
The landscape of stock-valuation measures doesn’t paint a pretty picture of what’s to come in the market.
In a November 15 note to clients, Bank of America said 15 of its 20 market-valuation measures were historically high.
Some of the most notable, all registering at least two standard deviations above their historical averages, are:
- Schiller price-to-earnings ratio (3 standard deviations above historical average)
- Price-to-book value (2.3)
- Enterprise value-to-earnings ratio before interest, taxes, depreciation, and amortization (2.2)
- Price-to-operating cash flow (2.6)
- Enterprise value-to-sales ratio (2.5)
- S&P 500 market-cap-to-GDP ratio (3.4)
Forward-looking investors have bid up valuations in a hyperliquid market on the expectation that long-term growth earnings growth will be stellar. Such a scenario would bring valuations back down to norms without causing a sell-off. The impressive earnings would eventually add up to justify current share prices in the market.
But that’s not the scenario that strategists at Bank of America led by Savita Subramanian see playing out. Instead, they said they believed investors’ expectations for growth were too high. Right now, expectations are above those during the dot-com bubble.
But high expectations have historically come with disappointing results. According to Bank of America’s measures, the correlation between growth expectations and S&P 500 returns indicates stocks will be due to drop 20% over the next 12 months.
“LTG rates are better contrary than positive indicators, like most sentiment measures,” Subramanian said in the note. “In fact, only 15 companies out of 87 companies with 20%+ LTG expectations as of 2000 generated 20% EPS CAGR over the next five years.”
Beyond the next year, the bank’s chief strategist sees negative returns — minus 0.5% — for the S&P 500 over the next 10 years given where valuations are. The analysis found that valuations at a point in time accounted for 80% of a stock’s performance over a subsequent decade. The strategists predicted the S&P 500 would be at 4,420 in 2031. That would be about a 6% decline from today’s levels of about 4,700.
Sectorwise, consumer-discretionary stocks have the worst outlook for returns, the bank said. Energy stocks, meanwhile, have the best prospects.
The bigger picture
Subramanian is one of the more bearish strategists among those at major Wall Street institutions. Her model showing a 20% decline over the next 12 months would put the S&P 500 at about 3,750 by Thanksgiving next year.
Goldman Sachs Chief US Equity Strategist David Kostin, meanwhile, has a 2022 S&P 500 price target of 5,100, which is 8% upside. Wells Fargo’s Christopher Harvey has said he thinks it can climb as high as 5,300.
But there are those who side more with Subramanian. Morgan Stanley’s Mike Wilson said 2022 would be the “year of the stock picker” as the S&P 500 ran out of steam, given where valuations are. His base case for the broad index next year is 4,400. Wilson set his target even though he predicted GDP and earnings growth would be strong next year.
The US economy — and, by extension, the stock market — is in a pool of uncertainty as indicators give mixed signals.
GDP growth slowed to 2% in the third quarter, below an expected 2.7%, likely, in part, because of rising cases of the Delta variant. Inflation has also risen above expectations for seven straight months and is at three-decade year-over-year highs of 6.2%. And the Federal Reserve will begin tapering its asset purchases this month.
But job gains picked up steam in October. The US added531,000 jobs last month, more than the expected 450,000, after a lackluster September reading. And the unemployment rate continues to fall toward pre-pandemic lows. It sits at 4.6%.
Further, consumer spending remains robust. Americans spent $638 billion in October, the most ever in a month.
But again, valuations play a major role in how a stock will perform. Even if firms’ earnings are great, history shows valuations come back toward their long-term averages. And Bank of America’s models show just that happening.
Stocks may or may not suffer a big pullback in the months ahead. Regardless, it’s reasonable to expect that the S&P 500’s 104% gain since the March 2020 bottom will soon run out of steam.