With stocks at all-time highs, Bank of America is sounding the alarm bells that a correction is on the horizon. Here’s what investors need to know now.
Stocks rallied higher this week as a new administration took over in Washington D.C.
Both the S&P 500 and the Nasdaq closed at record highs on Thursday, marking the second record day in a row.
But with stocks at all-time highs, Bank of America (NYSE: BAC) says there’s a correction coming for the market as prices already reflect a massive wave of government spending and central bank aid that can’t get much larger from here.
Valuations are high, and the equity risk premium—the earnings yield on the average S&P 500 stock minus the yield on the safe 10-year Treasury note—is at around 3.2% – and the lower the premium, the more richly valued stocks are. Historically, the risk premium doesn’t often fall below 3%, but when it does, it typically indicates market weakness ahead.
Investors worth a combined $561 billion surveyed by Bank of America rated their optimism for the market at 7.1 on a scale of 1 being deep pessimism to great bullishness at 10, with the closer a reading moves to 10, the more reason for concern.
With Bank of America clients their most optimistic on profit expansion since 2002, “extremely bullish” sentiment raises the risk that a market correction is “imminent,” wrote strategists led by Michael Hartnett in a report out earlier this week.
“Post-inauguration correction [is] likely on peak policy,” Hartnett wrote, citing “bubbly liquidity and stimulus checks.”
Hartnett and his team aren’t the only ones on Wall Street sounding the alarm. Canaccord Genuity’s Chief Market Strategist Tony Dwyer said last week that a downward move of roughly 8% in the S&P 500 is likely in the near term, while BlackRock CEO Larry Fink said he sees a 5% to 10% correction on the horizon.
But with the risk of a correction rising, Goldman Sachs (NYSE: GS) says investors should use any dips in the market to buy stocks.
Goldman strategists led by Peter Oppenheimer said in a note this week that, rather than fearing potential bear territory, the market is in the early stages of a bull phase following an “explosive” valuations-led rebound in equities that tends to start in recessions and marks the beginning of a new cycle.
“The market is rising on good news but choosing to largely ignore weaker data and rising infection rates,” Oppenheimer’s team wrote. “There is a risk of a correction, but without a bear market inflection.”
Goldman added that while the global financial crisis produced a “structural bear market,” the coronavirus-induced recession and market selloff were driven by events – thus circumstances are different this time around.
“The unprecedented speed and scale of policy support during the pandemic, designed to reduce the risk of longer-term scarring, has also reduced the risks of structural scarring and tail risks for investors, allowing them to ‘look through’ the downturn into a recovery,” the Goldman strategists wrote.