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(Bloomberg) — Optimists expecting the stock market to weather the rate-hike cycle as they’ve done in the past are missing one important detail, according to Bank of America Corp.’s strategists.
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While U.S. equities saw positive returns during previous periods of rate increases, the key risk this time round is that the Federal Reserve will be “tightening into an overvalued market,” the strategists led by Savita Subramanian wrote in a note.
“The S&P 500 is more expensive ahead of the first rate hike than any other cycle besides 1999-00,” they said.
U.S. and European stocks have made a rocky start to 2022 amid concerns that more aggressive monetary steps to tame inflation will hamper the recovery. While a positive earnings season is easing some worries over a less forgiving macroeconomic backdrop, equity markets have remained volatile, and strategists are divided about what lies ahead for the rest of the year.
BofA’s team is squarely in the bears’ camp, expecting the U.S. benchmark to end the year at 4,600 points, implying just 2% upside from current levels. The strategists argue that the closest historical precedent to the present outlook is the monetary tightening at the turn of the century, which “ended poorly” for stocks with the bursting of the tech bubble.
“The pivot from super dovish to more hawkish policy underscores that we are at the point of peak liquidity,” they said in the note on Monday.
While other notable Wall Street voices, including Morgan Stanley’s Michael Wilson, share their pessimism, the assessment is by no means the consensus view. JPMorgan Chase & Co.’s team reiterated on Monday that growth will remain solid this year and with still more upside for equities, following the ferocious rally of 2021.
For BofA’s strategists, though, an abundance of red flags including valuations, sentiment, fundamentals and technical factors point to a poor year for equities.
“Moreover, we believe that risks to equities would be greater if the Fed did nothing,” they wrote. “Runaway inflation would likely compress S&P 500 multiples and cut into earnings.”
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