BofA sees a silver lining for the stock market’s 25% drop this year: Valuations have been reset and US investors should be able to avoid a ‘lost decade’

• The silver lining of the stock market’s 25% decline this year is that there’s less risk of a “lost decade” in the future, according to Bank of America.
• The bank’s long-term valuation model points to annualized gains of 6% over the next decade.
• But the stock market is not out of the woods yet as there could be more pain in the short term.

There have been no more warnings of a “lost decade” stock market returns in recent months, but the odds of that actually happening seem less likely given the massive 25% decline this year.

This is according to a Friday note from Bank of America strategist Savita Subramanian, who was one of the first on Wall Street to warn of a potential lost decade at the end of last year.

She pointed out that with falling stock markets comes falling valuations, which are now starting to look attractive to longer-term investors. The S&P 500’s price-to-earnings multiple has compressed significantly so far this year, with trailing and forward P/E ratios dropping 36% and 29%, respectively.

A valuation model used by the bank suggests annualized forward price returns of 6% for the S&P500 over the next decade. This is the highest return prediction since May 2020.

“Valuation matters over the long term, explaining about 80% of subsequent 10-year S&P 500 returns,” Subramanian said. “And this year’s bear market presents an attractive opportunity for long-term investors.”

If the forecast is correct, that would put the S&P 500 just above 6,500 by 2032, which represents nearly 80% upside potential from Thursday’s close. With the addition of a 2% dividend yield, total annualized returns could reach 8%, according to Subramanian.

But while the long-term outlook looks the best in more than two years, the short-term looks riskier for the stock market, and “the short-term pain remains,” she said.

“While the S&P 500 has fallen below our year-end target of 3,600, we continue to expect volatility in the market,” Subramanian said, adding that only 20% of his market indicators bullish were positive so far. Typically, past stock market lows have seen 80% of these indicators flash green, according to the note.

And higher inflation in the services sector rather than the goods sector “is a double whammy” for stocks, she added. “Unlike the US economy (70% services), S&P 500 earnings are 50/50 goods/services. Moderating goods inflation indicates weakening pricing power for goods-focused companies. goods.”

Additionally, rising services inflation reinforces the Federal Reserve’s view that it should remain hawkish and continue raising interest rates, raising the risk of a harder landing, Subramanian said. . Such a hard landing would put the bank S&P 500 recession scenario 3,000 price target in playbut would likely make valuations much more attractive for Subramanian over the long term.