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BofA Strategists See 7% Stock Drop by Year-End

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What You Need to Know

  • They're targeting 4,250 for the S&P 500 by year-end.
  • Contributing to the outlook: supply chain issues, China's slowdown and expectations of Fed tapering.
  • The strategists say the index could experience a minus 0.5% annualized price return over 10 years.

Despite another run at record highs in the stock market, Bank of America strategists see “more downside risk to the S&P 500 through year-end,” with a target of 4,250, about 7% below late-afternoon trading on Tuesday.

They cite extended valuations and near-euphoric market sentiment as well as supply chain issues, labor inflation, potential tax increases, an energy crisis, China GDP risks and peak globalization posing risks for the continued stock market rally. Federal Reserve tapering, which could begin before year-end, will also weigh on this year’s stock market. “Based on the historical relationship, tapering is estimated to result in 3% downside in the S&P 500 by year-end and a flattish market through year-end 2022,” according to the BofA report.

The strategists’ longer-term outlook is also pessimistic, suggesting a minus 0.5% annualized price return over 10 years, its first negative return forecast since 1999.

The strategists, led by Savita Subramanian, stress “dividend preservation and growth as the single most important criteria for stock selection” over the next 10 years. That focus could potentially mean the difference between a flat to negative returns and positive returns for the S&P 500 over the next 10 years, according to the BofA report.

Although third-quarter earnings and margins are beating expectations, margins are expected to peak next year due to increasing labor costs and longer lasting supply chain risks, according to BofA.

Not all is negative in the BofA outlook, however. The strategists see potential gains in small-caps, which are cheap compared with large-caps; value over growth — also less expensive —- and U.S. stocks over multinational equities, due to fewer risks. Value and small-caps could benefit if the number of COVID-19 cases continue to decline, according to strategists.

“COVID case counts matter more” than the late cycle that the market is in, according to the strategists.

Among one of the more surprising findings in the BofA report: China’s GDP has more influence on S&P 500 earnings than U.S. GDP, which it notes poses a risk to materials and technology sectors. (Technology stocks account for about 27% of the cap-weighted index.)

BofA economists recently slashed their China GDP forecasts, which adds another negative hit (minus 4%) to S&P 500 earnings per share. U.S. multinational companies with exposure to China are particularly vulnerable since investors’ sentiment toward those stocks hasn’t changed much, “suggesting more pain to come,” according to the BofA report.