Yesterday, we reported that Morgan Stanley’s chief equity strategist – and biggest Wall Street bear with a handful of exceptions – took a preemptive victory lap, and capitalized on the recent market rout which has left his bullish colleagues scrambling who to revise their narrative, to predict even more pain for stocks in the first half including a 10-20% correction in H1, even though technically at 4,500, the S&P is still some 100 points away from his 2022 base case target for the S&P500.
But if Wilson’s victory lap may seem premature in retrospect, especially if stocks soar from here, Bank of America’s chief equity strat, Savita Subramanian has every reason to float – while not nearly as bearish as Wilson, her year-end price target of 4,600 has already been hit, prompting a difficult question: “Is it 2023 yet?”
As Subramanian gloats, “the S&P 500 now hovers just below our year-end target of 4600 already” adding that “elements of our too bearish call last year are playing out today.” Here’s why:
Last year, we underestimated margin preservation of corporates amid rising inflation, and failed to forecast that negative real rates would fall further. But wage pressures are now starting bite and real rates have risen ~50bp this year.
In 2021, we underestimated the impact of liquidity on stocks: Fed balance sheet increases have explained more of S&P 500 returns than earnings post-GFC; if we plug last year’s balance sheet expansion into this historical relationship, our liquidity framework yields an S&P 500 2021 year-end price ranging from 4500 (using rate of change in Fed asset base) to 4900 (using chg.); the actual close was 4766.
To be sure, Subramanian was also quite bearish in 2021 as well, but as she writes in the mea culpa, she underestimated margin preservation of corporates amid rising cost pressure. She also notes that the S&P 500’s 27% price return was entirely due to upward earnings revisions, as the forward P/E actually compressed by 5%. This followed 2020’s purely multiple-expansion-driven gains. In 2021, all sectors’ except Real estate and Utilities saw returns driven by EPS revisions; meanwhile Energy saw the biggest EPS revision, driving its gains, and as Subramanian notes, “stocks with positive estimate revisions saw higher returns than any other factor we track.”
And while Savita can certainly take the W and pull her price target for the time being before deciding how to proceed once things stabilize, she – like Wilson over at MS – remains steadfastly bearish, and forecasts EPS growth to slow from ~50% in 2021 to trend 6.5% in 2022, coupled with even more multiple compression as revisions and guidance have weakened. Staples and Communication Services – two sectors BofA is underweight –have seen the weakest revisions/guidance…. and finally wages are starting to bite, as downward guidance around cost pressure has begun to materialize in earnest.
Another simple reason why BofA remains bearish is that as shown in the charts below, Fed liquidity was the main driver of returns in 2021… liquidity which won’t be coming back until the next crash.
And while the liquidity handoff from Fed/government to consuemrs/corporates is bullish for the economy, it is bearish for stocks.
The liquidity transfer: Fed & gov. spent money and now cash balances are high Following a ~$11T increase in the Fed balance sheet and money supply (M2), the Fed and US government successfully injected much needed liquidity into the system and saved the world. Now, the consumer and corporates are sitting with a record $19T in cash, a 35% increase from 2019.
Why is this bearish for stocks? Because historical relationships between cash balances versus M2 and versus Fed balance sheet expansion suggest that consumer cash is more tied to money supply (the real economy) than Fed balance sheets, while corporate cash is tied to the real economy and to monetary policy by similar magnitudes. With quantitative tightening expected this year – with balance sheet reduction of over $600B in 2022 (house view), corporates are more likely to see the negative impact via a rising cost of capital and asset deflation, than the consumer will.
Then, after several pages of factor analysis, BofA focuses on its regime indicator – which aggregates macro indicators to yield four phases of the cycle – and concludes that the US has shifted from “Mid Cycle” in earlier 2021 to “Late Cycle” in August. Historically, High Quality, Low Risk and High Dividend Yield performed best in this phase. Free Cash Flow also typically outperforms.
And since we are late cycle, the next big event is recession. As for markets, she concludes that the “hawkish Fed changes the story in 2022. With quantitative tightening expected later this year, our liquidity framework above suggests muted returns from here – 4600 on the S&P 500 by year end, and just +1.5%/yr over the next three years based on YoY Fed balance sheet change and +2.8%/yr based on rate of change.”
There is much more in BofA’s full report (available as usual for professional subs) but readers get the message: the S&P has hit BofA’s price target of 4,600 and according to the bank’s chief equity strategist, we aren’t going anywhere for the next 3 years (and if we are going somewhere, it’s lower).
