Bank of America says why investors should buy into an ‘extraordinarily expensive’ stock market

• The stock market may be expensive based on traditional metrics, but that doesn’t mean investors should avoid stocks.

• Bank of America said comparing current valuations with past values ​​is like comparing apples to oranges.

• “The S&P 500 has half leverage, higher quality and lower return volatility than in decades,” BofA said.

The stock market is “terribly expensive” than in the past, but that doesn’t mean investors should avoid stocks, Bank of America’s Savita Subramanian said in a Wednesday note.

The US stock strategist said that although the S&P 500 index is “statistically overvalued in 19 out of 20 indexes and trades at the 95th percentile of price returns based on data dating back to 1900,” this does not mean that stock prices cannot rise. He said no. It will continue to rise from here, and for good reason.

In particular, Mr. Subramanian objected to comparing stock market valuations in the past and present, when the composition of the S&P 500 was very different.

“I think one of the bear stories that I hear a lot and I want to debunk is just this idea that the market is too expensive,” Subramanian told CNBC on Wednesday. “People will compare the S&P today to what it was 10 years ago, 20 years ago, 30 years ago, 40 years ago. I don’t think that makes sense because today’s market is a completely different animal. .”

The S&P 500 index currently trades at a 12-month price-to-earnings ratio of 24.5x, well above the 10-year average of 21.1x. Meanwhile, the S&P 500’s forward price/earnings ratio (P/E) is 20.4 times, more than one standard deviation above the 30-year average of 16.6 times.

But given that the companies in the S&P 500 are much more profitable today than they were in the past, Subramanian suggests the S&P 500 may be trading at a higher valuation than it was 30 years ago. .

“The S&P 500 is half as leveraged, has higher quality, and has less volatility in returns than it has in past decades. % to 50% in asset-light technology and healthcare companies,” she explained.

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And that different composition is reflected in the S&P 500’s returns, which have doubled from less than 6% in the 1980s to nearly 12%.

“We’re in a different ball game here, so you can’t just look at today’s S&P and take that P/E ratio and compare it over time,” Subramanian told CNBC.

Overall, despite historically high market valuations, stocks are likely to continue trending higher unless corporate earnings plummet from current levels.

“This realistic good-case scenario suggests that the fair value of the S&P 500 is around 5,500,” Subramanian said, indicating a potential 9% upside from current levels. said.

Read the original article on Business Insider