BofA Analyst: 'The Market Is Far From Overvalued'

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new york stock exchange trader bank of america merrill lynch wall street investing
Richard Drew/AP
By Mathew Boesler

Bank of America Merrill Lynch equity strategist Savita Subramanian is bullish on the stock market.

Recently, she hiked her S&P 500 year-end price target to 1,750 from 1,600, one of the most optimistic forecasts on Wall Street. (The index closed Thursday at 1,697, so Subramanian's target implies an additional 3.1 percent upside through the rest of 2013.)

"With the S&P 500 rising over 20 percent over the past twelve months and continuing to make all-time highs, the pervasive refrain is that the market has grown expensive," writes Subramanian in a note to clients.

"Admittedly, the majority of 2013's gains have come from multiple expansion rather than earnings growth, but the market is far from overvalued. This suggests that the market has merely played catch up with fundamentals -- recall that earnings made new highs in 2010. Valuation remains a driver for our bullish view on stocks."

The table below shows 15 popular S&P 500 valuation metrics:

bank of america merrill lynch wall street stocks investing
BofA Merrill Lynch US Equity & US Quant Strategy
"The majority indicate that the market is still trading below or in-line with historical norms, suggesting that the rally has chiefly been driven by a recovery in multiples from very depressed levels," says Subramanian.

The one metric of the 15 that says stocks are expensive is the Shiller price/earnings ratio:

The Shiller P/E, which is based on inflation-adjusted earnings over the past 10 years, currently suggests that stocks are overvalued. However, this metric assumes that the normalized (cyclically adjusted) EPS for the S&P 500 is today less than $70 -- well below even our recessionary scenario for EPS.

The methodology assumes that the last 10 years is a representative sample, but the most recent profits recession was the worst we have seen and was exacerbated by a high leverage ratio which has since been dramatically reduced. Assuming that this scenario is going to repeat itself is, we think, overly pessimistic.

Subramanian argues that if stocks are expensive, "other asset classes are really expensive."

"While the relative attractiveness of stocks versus bonds, as measured by the equity risk premium (ERP), has moderated from all-time highs, the ERP still remains well above historical norms," writes the BAML strategist. "And compared to commodities, stocks are sill attractive -- the price of the S&P 500 in WTI oil terms is currently 16 [oil barrels], vs. the historical average of 22 [oil barrels]. Similarly, the S&P is trading at 1.3x the price of a Troy oz. of gold, while it has historically traded at 1.5x."

That's not to say some stocks aren't expensive. Subramanian flags the consumer discretionary sector as overvalued versus historical norms, along with "the more defensive, high-yielding, domestically-focused stocks within Telecom and Utilities."

Less overvalued, according to Subramanian:
  1. Cyclicals
  2. Dividend growth
  3. Globally diversified stocks
  4. Stocks with low earnings volatility, especially in the tech, industrial and energy sectors.


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24 Comments

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mccglf

Wow. Bank of America's track record of market prognostication speaks for itself. If they say buy, we should all be running for the exit doors. FAST

August 12 2013 at 6:56 PM Report abuse rate up rate down Reply
ptm453

This article was very interesting. I also found this interesting lecture about forecasting the market that I think you might like. Let me know what you think.

Google:" How Can We Predict The Market By Using Algorithms? University Lecture By Dr. Lipa Roitman"

August 12 2013 at 11:12 AM Report abuse rate up rate down Reply
mgh406

Everyone knows it is the Bernanke Bubble. The wall street schisters just want to keep prices high untill they bail out.

August 11 2013 at 1:21 PM Report abuse +3 rate up rate down Reply
jekap55

Aren't these the people who gave us the last bubble and ensuing implosion?

August 11 2013 at 12:19 PM Report abuse +3 rate up rate down Reply
boyadj45

her head should be examined. these analysts ive a glimpse of a report. no depth, and only academic knowledge.

August 11 2013 at 12:03 PM Report abuse +1 rate up rate down Reply
sfreedomsoul

And we know that Bank of America wold never lie or engage in pump an dump.

August 11 2013 at 11:51 AM Report abuse +4 rate up rate down Reply
ptm453

This article was interesitng. I found another article about Apple from Seeking Alpha that i think you wil find interesting as well. Let me know what you think

http://ow.ly/nOTPo

August 11 2013 at 10:20 AM Report abuse rate up rate down Reply
nevada4me

"The majority indicate that the market is still trading below or in-line with historical norms, suggesting that the rally has chiefly been driven by a recovery in multiples from very depressed levels," says Subramanian.

Really? The Fed has been pumping 85 billion a MONTH into the bond market for YEARS to produce the lowest interest rate level ever seen by most market participants. With record public debt, doubling the 30 year bond rate to "historical norms" will result in more and more money going to pay that debt. Yet over half of all Americans pay no Federal Income Tax at all & over half already receive a check directly from the government. It's always fun & games until the bill comes due. Ask the Greeks.

August 11 2013 at 5:22 AM Report abuse +2 rate up rate down Reply
1 reply to nevada4me's comment
HiBarbRayAndMeg

You repeated all the talking points from a certain party.. Which has not been correct on anything for quite some time. Stocks were doing great before QE3 due to going lean and mean, outsourcing, and not having to pay their fair share in income taxes.. That is right, corps have legally been avoiding paying taxes. Loopholes, special tax breaks, etc etc etc are a wonderful thing, the best that money can buy. armies of lobbyists are a godsend for all these companies.. That is why I will continue to be fully invested.

August 11 2013 at 11:19 AM Report abuse -2 rate up rate down Reply
nevada4me

Hmmmm...I wonder who's name is at the bottom of this genius' paycheck?

August 11 2013 at 5:03 AM Report abuse +2 rate up rate down Reply
nevada4me

B of A analyst translation = "Please don't stop buying, we have plenty of risk left to sell you. We prefer cash. We squeezed billions from your home equity, but that well has dried up. Now we have our sights set on all those fat 401ks, I.R.As, and pensions."

August 11 2013 at 5:00 AM Report abuse +4 rate up rate down Reply