- Bank of America strategist Savita Subramanian has a bleak outlook for stocks going forward.
- She said in a recent note that data indicates the S&P 500 may fall 20% over the next 12 months.
- Many stock valuation measures are currently extended by historical standards.
The current 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 shared that 15 of their 20 market valuation measures are historically high.
Some of the most egregious offenders, all currently registering at least two standard deviations above their historical averages, include:
- Schiller price-to-earnings ratio (3 standard deviations above historical average)
- Price-to-book value (2.3)
- Enterprise value-to-earnings before interest, taxes, depreciation, and amortization (2.2)
- Price-to-operating cash flow (2.6)
- Enterprise value-to-sales (2.5)
- S&P 500 market cap-to-GDP (3.4)
Forward-looking investors have bid up valuations in a hyper-liquid 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 believe investors’ expectations for future growth are too high. Right now, expectations are above those seen during the dot-com bubble.
But high expectations have historically come with disappointing results. According to Bank of America’s measures, the correlation between future growth expectations and actual S&P 500 returns show that stocks would 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 — -0.5% — for the S&P 500 over the next 10 years given where valuations are. Their analysis found that valuations at a point in time account for 80% of a stock’s performance over a subsequent decade. They predict the S&P 500 will be at 4,420 in the year 2031. That would be about a 6% decline from today’s levels around 4,700.
Sector-wise, consumer discretionary stocks have the worst outlook for future 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 around 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 Chris Harvey thinks it could climb as high as 5,300.
But there are those that side more with Subramanian. Morgan Stanley’s Mike Wilson said that 2022 will be the “year of the stock picker” as the S&P 500 runs out of steam given where valuations are. His base case for the broad index next year is 4,400. Wilson’s target is despite the fact that he thinks GDP and earnings growth will be strong next year.
The US economy — and by extension the stock market — is in a pool of uncertainty at the moment as indicators give mixed signals.
GDP growth slowed to 2% in Q3, below an expected 2.7%, most likely in part because of rising cases of the Delta variant of COVID-19. Inflation has also risen above expectations for seven straight months now, and is at three-decade year-over-year highs of 6.2%. And the Federal Reserve will begin tapering their asset purchases this month.
But job gains also picked up steam in October. The US added 531,000 jobs last month, more than the expected 450,000, after a lackluster September reading. The unemployment also continues to fall back toward pre-pandemic lows. It currently sits at 4.6%.
Further, consumer spending remains robust. Americans spent $638 billion in October, the most ever in a month.
But again, current valuations play a major role in how a stock will perform in the future. 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 would be reasonable to expect that the S&P 500’s 104% gain since the March 2020 bottom soon runs out of steam.