Why Bank of America is bullish on the economy, but less so on the S&P 500
BofA Global Research, U.S. Equity Strategist and Head of US SMID Cap Strategy, Jill Carey Hall, joins Yahoo Finance to discuss the changing tones in the market as price targets shift and the critical risk for investors.
- Kids, let's welcome in Jill Carey Hall, US equity strategist and head of US Small and Mid-Cap Strategy at B of A Global Research Bank of America, Global Research that is. Jill it's good to see you. We will not ask you about light coin here this morning.
Rather, you know, Brian and I have been sort of discussing the change and tone for many on Wall Street, the sort of pivot to a more cautious tone. And I'm curious for your team at Bank of America, how you've sort of been coming to that view, because you guys just cut your S&P 500 forecast.
JILL CAREY HALL: Yeah, so we've been one of the more cautious strategy teams on the market with regard to the level of the S&P 500. We recently just revised actually upward our 2021 year end target and launched a 2022 year in target for the S&P. So for year end 2021, we are still expecting the market to end the year lower than current levels. So we have a 4,250 target on the S&P 500 for year end.
Obviously earnings have come in very strongly for the first half, much better than expected. And we're still bullish on US economic growth. But we think a lot of the good news has been reflected in valuations at this point, which are very stretched, particularly for a lot of the large and mega cap stocks within the market. And sentiment has been close to euphoric.
Our survey of other Wall Street strategists and what they're recommending you put into equities in a balanced fund has been at levels that, by our measures, is pretty close to a sell signal. It's still in neutral territory. But we're getting pretty close to levels that would suggest more caution on the market. So you know, so far so good this earnings season also with respect to margins and inflation. But I think that's going to be a key risk in the second half, as we've seen mentions of inflation and wage pressures and supply chain issues really skyrocket on earnings calls as well.
So potential risk for year end. And then for 2022 we're only looking for limited upside to the market from current levels with a 4,600 target on the S&P for a year end '22.
- Jill, staying on that 4,250 target, is that a target that is hit over the next 6 to eight weeks because of a fed meeting, because of earnings season, and all these potential negative developments that could unfold.
JILL CAREY HALL: Well look, I mean you know as a strategist, we're were asked to sort of peg where the market ends the year at year end, December 31. But I think you know in over the course of the come in coming weeks and months there are a number of risks. Obviously COVID is one of them. But you know, interest rates, the fed, all of this is something that we're watching closely.
One thing we pointed out is that the interest rate sensitivity of the S&P 500 is extremely elevated right now. You have a lot of long equity duration stocks so to speak, so stocks that are sensitive to interest rates a lot of these big mega-cap growth stocks that are a very high concentration of the market right now and more sensitive to interest rates. We are of the view that their rates are more likely to go higher rather than lower from here.
And so within the market, we would stick with areas that we think could be better positioned even though we're not suggesting upside to the overall S&P 500 for year end, there are still some areas within the market that we would be more positive on, inflation protected yield being one of those areas, so within the S&P stocks that have healthy and growing dividends and are better positioned as inflation rises, so some of the more inflation oriented sectors, energy, financials has healthy dividend growth, even parts of real estate materials, et cetera.
- And Jill, also, small caps. And small caps do they tend to be more weighted towards those areas you're talking about or why do they tend to be more, maybe more inflation resistant?
JILL CAREY HALL: That's right. Yeah, we've been bullish on small caps relative to large caps. And you know for what we were speaking about earlier, you know we're still positive on US economic growth. And small caps are more tethered to a bullish US growth outlook. They're more tethered to services spending.
Their sales are more tethered to a CapEx pickup in the US. So we are starting to see signs of better CapEx spending by US corporates. That could be furthered by an infrastructure bill as well as the multiyear theme of reshoring of US manufacturing with all of the supply chain shifts that we've seen, you know, COVID, US-China trade tensions have obviously furthered this.
And one of the other interesting things that we found is that our valuations for the market, obviously they're a bit extended across the board for US equities much more so up the cap spectrum in large and mega caps. But for small caps they're still trading at a historical discount to large caps. And while valuation doesn't always necessarily tell you much about what's going to happen to the market over the coming days or weeks or even months, it does have a very high explanatory power on returns over the next decade.
So if you're a long term investor, one interesting thing we found is that for the first time our long term valuation framework is suggesting that the S&P 500 large cap benchmark could actually see negative annualized returns over the next decade. But for small caps that's not the case. So our framework is spitting out a positive mid to high single digit annualized return forecasts for small caps. So if you're a long term investor this might be a better area to tilt to for better annualized gains.
- Jill, how large a risk is it that small cap call that we do-- we could very easily get higher corporate taxes? That debate has resurfaced here to kick off this week. How big a risk is it to US focused companies that they may have to pay more on their already minuscule profits out to the government?
Right. Yeah, I mean this is certainly a risk for equities across the board. So there's obviously various components to President Biden's tax plans. Higher corporate tax rate could be more impactful to some of those US focused companies, as you mentioned, within both Russell 2000 as well as even within the S&P 500.
Whereas on the flip side, some of the other components of the tax plan that would be more targeting to international companies could hit some of those areas that you see within the mega caps. So higher taxes is one risk to the earnings outlook for next year. The trajectory of COVID cases will obviously be another risk since small versus large cap performance has been relatively correlated with that.
But if we do start to see a better backdrop in that regard, I think given the bullish themes for the outperformance of US growth relative to other regions it could be a good multiyear backdrop for smaller stocks.
- We will keep an eye on it. Jill Carey Hall, good to catch up with you of Bank of America. Thanks so much. Appreciate it.