A report released Tuesday by Bank of America’s Research Investment Committee showed that the bank’s target price for the S&P 500 in 2021 is 3,800 points, one of the lowest expectations among many Wall Street investment banks.
The bank expects the U.S. stock market to see a 5-10% correction in the first quarter, as the market has become overly optimistic. However, the bank believes that this will also be an opportunity to enter the market in a larger bull market.
Warnings about overly optimistic markets are not uncommon, as investment banks such as Goldman Sachs, Citi and JPMorgan Chase have all issued similar warnings recently. Now, the same warning has been issued by Bank of America, which has reached a record 92% on its proprietary global research metrics.
This means that the U.S. stock market is in the midst of unprecedented optimism, with the Fed’s easing, expectations of fiscal stimulus and steadily ongoing vaccinations combining to create this situation. But the fundamentals are not as optimistic as the stock market.
It’s not just the fundamentals that are unstable: Steve Sattemeier, chief equity technical strategist at Bank of America, noted that while the core view remains bullish, there are some risks that have to be watched, such as: the ratio of puts to calls and the seasonal pattern in February, all of which pose a threat to U.S. stocks.
In addition, Bank of America added three risks.
First, the cyclical peak in equity market issuance could occur in the first half of 2021. Bank of America notes that U.S. equity issuance has already surpassed records set during the dot-com bubble, and that the S&P 500 has seen a decline in its price-to-earnings ratio after the last two peaks.
Meanwhile, the number of unprofitable IPOs has been hovering around 80% for the past two years. This means that not since 2000 have U.S. investors been asked to buy so many new, unprofitable companies.
Second, small-cap stocks could see a sharp correction. The “incredible rally” in small-cap stocks in recent months is a strong bull signal, and on average, small-cap rallies last 10 years. However, as Bank of America warns, so far this rally has not been backed by company earnings growth.
Finally, the bank warns that among global companies providing earnings guidance, a record number of companies have raised their earnings per share estimates in the past six months, more than in 2004 and 2009. While actual earnings growth may not top out until later this year, stock markets are always forward-looking.
In other words, the current perverse rise in the share prices of many companies beyond expectations means that it only takes a very small external shock to cause a series of sell-offs.
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