Bank of America: The stock market is primed for a 25% rally in the next 12 months. These 6 industries hold the best opportunities.
- Stocks sold off in August and have stayed stuck in September.
- Investors are worried, and analysts have low long-term growth expectations for stocks.
- But that’s exactly why stocks could rally over 25% in the next 12 months, according to BofA.
The S&P 500’s rally has been stalled since August, but stocks are far from cheap these days.
In a recent note to clients, Bank of America equity & quant strategist Jill Carey Hall wrote, “It’s nearly impossible to be bullish on the market capitalization weighted S&P 500 on valuation – it trades expensive on 19 of 20 measures we track.” “Our Dividend Discount Model Equity Risk Premium is the only measure on which the US market trades cheaply, aligned with our belief that the risk premium for stocks is too high and the so-called “risk-free” 10 year T-bond rate is too low.”
Although valuation is important in the long run, sentiment has a more immediate impact on share prices, according to Carey Hall. And, ironically, while sentiment appears to be turning bearish right now, stocks could rise dramatically over the next year.
Negative vibes equal positive results
While market-cap-weighted valuations may not appear to be cheap, equal-weight valuations aren’t all that bad — especially when you exclude the so-called Magnificent 7, which have outperformed the rest of the market this year.
According to Carey Hall, “PE ratios are roughly at historical average levels based on the equal weighted S&P 500.” In fact, according to Carey Hall, the S&P 500 trades only three standard deviations above its average when measured by PE to growth.
This is due to investor pessimism, particularly with regard to long-term growth (LTG) expectations. Carey Hall wrote that analyst consensus for LTG has plummeted since 2022 and is now near a record low, just a few percentage points shy of the March 2020 trough.
However, historically, low LTG expectations have been a strong predictor of positive future stock market returns.
“Low LTG has been positive. Indeed, given the strong inverse relationship between LTG and future S&P 500 returns, we cited lofty expectations as a bearish set-up in November 2021,” Carey Hall wrote. “Today’s LTG forecasts >25% price returns for the S&P 500 over the next 12 months, all else being equal.”
6 industries with profit opportunities for investors
So, if the market can truly rally by more than 25% in the next year, where should investors put their money now to maximize their returns?
Carey Hall observed that LTG expectations in the communication services sector are surprisingly high, given that interest-rate increases are typically a problem for long-duration sectors. Meanwhile, she wrote that energy expectations are shockingly low, given that earnings have increased by 40% in the last three years.
Overall, Carey Hall and her colleagues at Bank of America see opportunities in six industries based on three factors: price momentum, or the difference in an industry’s relative price this month vs. three months ago; earnings momentum, or the difference in relative forecast EPS this month vs. three months ago; and valuation.
Carey Hall believes that the best investment opportunities are in interactive media and services, household durables, media, passenger airlines, energy equipment and services, and insurance.
She also mentioned that the most appealing sectors right now are communication services, energy, and consumer discretionary.
