BofA Strategists Warn of Fed Hikes in Expensive Market

Optimists who expect the stock market to ride out the rate hike cycle as it has in the past are missing an important detail, according to strategists at Bank of America Corp.

Although the actions of U.S posted positive returns during previous periods of rate hikes, the key risk this time is that the Federal Reserve it will “adjust in an overvalued market,” strategists led by Savita Subramanian wrote in a note.

“The S&P 500 is more expensive before the first rate hike than any cycle other than 1999-2000,” they said.

US and European stocks are off to a rocky start in 2022 amid concerns that more aggressive monetary measures to control inflation will hamper the recovery. While a positive earnings season is easing some concerns about a less forgiving macroeconomic backdrop, equity markets have remained volatile and strategists are divided on what lies ahead for the rest of the year.

The BofA team sides with the bears and expects the US benchmark to end the year at 4,600 points, implying just 2% gains from current levels. Strategists argue that the closest historical precedent to the current outlook is the turn-of-the-century monetary tightening, which “ended badly” for stocks with the bursting of the tech bubble.

“The turn from an overly expansive policy to a more restrictive policy underscores that we are at the point of maximum liquidity,” they said in the Monday note.

While other prominent Wall Street voices, including Morgan Stanley’s Michael Wilson, share his pessimism, the assessment is by no means the consensus view. The JPMorgan Chase & Co. team reiterated on Monday that growth will remain strong this year and sees further gains for stocks after the strong rally in 2021.

For BofA strategists, however, a host of red flags, including valuations, risk perception, fundamentals and technicals, point to a bad year for stocks.

“In addition, we believe the risks to equities would be greater if the Fed did nothing,” they wrote. “Runting inflation would likely compress S&P 500 multiples and eat into earnings.”