This Model Suggests Negative S&P 500 Returns Over The Next Decade

Bank of America has updated its S&P 500 price target for year-end 2021 and released its brand new year-end target for 2022. Unfortunately, the firm’s new estimates paint an extremely conservative picture of the next 16 months.

Limited Upside: On Wednesday, Bank of America analyst Savita Subramanian raised her year-end 2021 S&P 500 price target from 3,800 to 4,250. The new target still represents about 5.9% downside from the S&P 500’s current level of around 4,517.

Looking ahead to 2022, Subramanian set a new year-end S&P 500 target of 4,600, suggesting only about 1.8% additional upside for the index over the next 16 months.

She said the S&P 500 EPS is up about 50% from its COVID-19 trough, yet the stock market has doubled. She also pointed out that investor sentiment is at its most bullish levels since 2007, a potentially bearish contrarian indicator for stock prices.

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In addition, Subramanian said inflation is weighing on margins, interest rate risk is at a record high and stocks appear to be priced for perfection.

While Bank of America is bullish on the U.S. economy in coming years, Subramanian said about half of the S&P 500 returns since 2010 have been driven by Federal Reserve balance sheet expansion rather than earnings growth. Economists now expect the Fed to begin tapering its monthly asset purchases by the end of 2021.

Historically High Valuation: Subramanian said an end to monthly Fed asset purchases and then eventual asset sales “could end badly” for the stock market. In fact, the firm’s long-term valuation model now suggests negative overall returns for the S&P 500 over the next decade.

“Canaries are chirping – PPG, a barometer of industrial activity, aborted guidance on supply chain woes; credit spreads have stealthily widened, and our valuation model (~80% explanatory power for S&P 10yr returns) now indicates negative returns (-0.8% p.a.) for the first time since ‘99,” Subramanian wrote in a note.

For now, she recommends investing in inflation-protected yield and small-cap stocks. Subramanian also recommends stocks in sectors that benefit from inflation, such as the energy, financial and materials sectors.

Benzinga’s Take: If investors trust the Bank of America long-term valuation model, S&P 500 index funds like the SPDR S&P 500 ETF Trust SPY will likely drift sideways at best for the next 10 years. Instead, sector ETFs like the Financial Select Sector SPDR Fund XLF, the Materials Select Sector SPDR Fund XLB and the Energy Select Sector SPDR Fund XLE could be the best bets.

Photo: Artem Podrez from Pexels

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