In was barely a month ago when, during remarks to Bloomberg Television, BofA’s Jill Carey Hall said the bank was sticking with their year-end S&P target because “a lot of the good news has been priced in.”
She was right. A lot of good news has been priced in. And it’s been priced in for months.
Nevertheless, US equities steadfastly refused to sell off at the benchmark level, even as “frothy” corners of the market de-rated or even fell into corrections and bear markets.
As a reminder, we’re (still) in the longest stretch without a 5% selloff since Janet Yellen’s short vol bubble (familiar figure below).
When Carey Hall spoke to Bloomberg, the S&P was around 4,440. BofA’s target was 3,800. Fast forward four weeks and the benchmark is at 4,500. Reality was running away from Carey Hall and Savita Subramanian so, on Wednesday, they marked to market. Sort of.
In what I’m sure was a begrudging update, Subramanian wondered “what good news is left?”
“S&P 500 EPS is up 50% from the COVID trough, and the [index] has doubled,” she half-complained, on the way to throwing in the towel. “We mark our models to market,” she said, raising the bank’s official S&P target to 4,250, which still counts as bearish.
“Sentiment is all but euphoric with our Sell Side Indicator closer to a sell signal than at any point since 2007,” she went on remark, on the way to fretting about the threat to margins from surging input costs and wage inflation. Margins, you’ll recall, hit a record in Q2.
Risks to profitability are hardly the only stumbling blocks. As alluded to Tuesday in “The ‘Just Can’t Win’ Dynamic,” equities (and especially secular growth) are vulnerable to rate shocks. Subramanian focused on the obvious. “Interest rate risk is at a record high, with S&P 500 equity duration equivalent to a 36-year zero-coupon bond,” she said, adding that “every 10bps increase in the discount rate equates to a 4% decline, all else equal.”
That risk is well documented. But, as noted in the linked “can’t win” piece, another dramatic drop in yields carries risks too. If the “growth scare” metamorphoses into something more tangible than a campfire ghost story and central banks inadvertently exacerbate it by tightening into a slowdown, sentiment could sour, rates vol could spike and all with ramifications for stocks. In other words: The risks to equities from rates are two-sided.
Subramanian also warned that valuations “leave no margin for error.”
Although BofA remains constructive on the economy, the world changed in 2008, after which “central banks became the white knight,” as Subramanian put it Wednesday, in the course of saying that prior to the financial crisis, earnings explained around half of S&P 500 returns.
Post-GFC, that figure is just 17% on BofA’s math. She then ventured to say that Fed balance sheet expansion explained more than 50% of returns over the past decade. As ever, I’d caution that it’s impossible to quantify that precisely. All we know for sure is that trillions upon trillions of liquidity has to go somewhere (figures below).
I don’t see much utility in editorializing any further around BofA’s mark-to-market exercise. The bottom line on Wednesday was that the bank’s new target for the benchmark is 4,250 by year-end, which suggests 6% downside.
Subramanian also launched a 2022 target. It’s 4,600. So, according to BofA, US equities have just 2% upside over the next 16 or so months.
“This may not end now. But when it ends, it could end badly,” Subramanian chided.
I’m reminded of Harley Bassman, who once said of MMT, “I do not believe that it is viable over the long-term; although as stated prior, it is unlikely my personal horizon will overlap its eventual denouement.”
A USD from the year I was born has only retained 11% of its purchasing power.
However, if you look at the equivalent S&P 500 returns over that same time period and then factor in the 11% remaining purchasing power, a USD from the year I was born would be worth $3.85 in purchasing power.