The U.S. stock market, as measured by the S&P 500 index, appears to be exiting the “best era” for growth in earnings per share in decades as sources of liquidity have dried up, according to research from Bank of America.
The S&P 500’s earnings per share are “more cyclically peaked than ever from low financing costs, buyback-fueled growth and peak stimulus,” equity and quantitative strategists led by Savita Subramanian said in a BofA Global Research note Tuesday. “Secular EPS growth is at a multidecade high.”
BofA, which has forecast the S&P 500
will see $200 in earnings per share in 2023, says “now is not a time to buy the (crowded) market index.” But the strategists said that “shifts in liquidity should drive opportunities within, and outside of, the index.”
“We may be exiting the best S&P EPS era, but we are likely entering the best stock pickers market in our careers,” they said. “We recommend being invested in equities but selectively.”
The strategists shifted their view of the materials sector to overweight from underweight, while moving utilities down to market weight from overweight. They also moved communication services up to market weight, from underweight, as Facebook parent Meta Platforms Inc.’s
stock buyback program lowered the sector’s duration risk, the report shows.
The S&P 500, a gauge of large-cap stocks in the U.S., is up more than 4% so far this year based on Tuesday afternoon trading. The index’s communication-services sector has soared almost 11% year to date, while shares of companies in materials have risen around 3% and the utilities sector is down almost 5%, according to FactSet data, at last check.
“We like the capital-deprived sectors,” the BofA strategists wrote. Financials, home builders, materials and fossil fuels are areas of the market that have been “starved of capital” for more than a decade, while technology is among those that have “enjoyed free money, amplifying the duration risk of the S&P 500.”
“Bloated growth sectors still need to rationalize capacity after overbuild,” they said. “Deflating a Treasury bubble will be unkind to bondlike and long duration stocks.”
‘Dried up’ liquidity
“Three sources of liquidity have dried up,” the BofA strategists said, pointing to the end of the Federal Reserve’s quantitative easing program seen during the pandemic, as well as fiscal and corporate stimulus. The Fed bought bonds, including U.S. Treasurys, under quantitative easing. The central bank is now in a period of so-called quantitative tightening, allowing bondholdings to run off its balance sheet.
“The two biggest buyers of treasuries – China and Fed – are done,” the strategists wrote, while fiscal stimulus is “unlikely.” On the fiscal front, the strategists cited the possibility of “gridlock” in Congress along with “deficit hawks’ nuclear option — using the debt ceiling to force spending discipline.” And now companies are “belt tightening,” they said, with layoffs seen in some areas.
The strategists said their EPS forecast for the S&P 500 this year is based on “a soft-landing offset by corporates’ nimble margin preservation, a capex cycle, and a stronger consumer” in a longer hiking cycle by the Fed. The Fed has been hiking interest rates to combat high inflation, resulting in a rise in Treasury yields that last year pummeled equities, particularly growth and tech stocks.
The yield on the 10-year Treasury note
was up about 14 basis points Tuesday afternoon at around 3.96%, FactSet data show, at last check. Treasury bond yields and prices move in opposite directions.
Meanwhile, BofA has a year-end target of 4,000 for the S&P 500.
The U.S. stock market was trading sharply lower Tuesday afternoon, with the S&P 500 sliding 1.9% to around 4,003, according to FactSet data, at last check. The tech-heavy Nasdaq Composite
was down 2.2% while the Dow Jones Industrial Average
shed 1.9% amid the rise in Treasury yields.