The Fed has more work to do, Bank of America strategist Savita Subramanian tells clients in today’s note.
History tells us that if the Fed starts to ease prematurely, we may witness a fresh wave of inflation. In this case, “market volatility in the short-run may be a smaller price to pay.”
On the valuation front, Subramanian notes that “stocks are cheaper but still not cheap.” The S&P 500 is trading at 18.4x trailing EPS after contracting about 30% YTD, which is more during the prior recessions (average is 20%). On the other hand, 16.7x forward (consensus) EPS is in line with multiples seen in the 2010s.
“But if we factor in 8% inflation multiples are far too high, and TINA (“there is no alternative” to stocks) is hard to argue amid a 4% cash yield by early 2023 (house view). These factors warrant, in our view, a lower multiple than what we enjoyed in the 2010s. And if a hawkish Fed means a higher likelihood of recession, this translates into a higher equity risk premium (ERP),” Subramanian told clients in a note.
Bank of America remains bullish on Energy and bearish on Materials with the latter ranking last in the firm’s tactical sector framework.
Elsewhere, the dollar strength is likely to keep hurting Tech and Consumer Discretionary.
“Both sectors’ relative sales have negative USD betas, but neither sectors’ valuations reflect this risk, trading at significant premia vs. history,” Subramanian concluded.