Bank of America (BofA) has issued a warning on US stocks following their record-setting rally. The bank said signals that appeared just before past bear markets are being detected one after another, and it advised investors to take profits.
Overheating Signals Multiply, With Some Stocks Pricier Than During Dot-Com Bubble
According to Bloomberg on Wednesday, BofA investment strategists including Savita Subramanian said there are "too many red flags" and advised investors to "take profits."
BofA analyzed that about 70% of bear market precursor signals have recently emerged. This is on par with the average level observed when stock markets reached past peaks.
The S&P 500 is statistically overvalued on 17 of 20 valuation metrics, and on eight metrics it was assessed to be at higher levels than during the dot-com bubble. The valuation metrics included the consumer confidence index, growth outlook, merger and acquisition (M&A) related indicators, and credit stress.
BofA diagnosed the phenomenon of high price-to-earnings ratio (PER) stocks significantly outperforming low-PER stocks as a "sign of excessive speculation." It also pointed to the widening return gap within technology stocks as a problem. Based on data from 1986 through May this year, the gap between the top 20% and bottom 20% of technology stocks by returns has widened to its largest since February 2000.
Subramanian said the S&P 500's strong rally is masking "internal turmoil." She noted that over the past three months, the return gap between the top 10% and bottom 10% of index constituents jumped to its highest level since the COVID-19 pandemic.
Some Tech Fundamentals Sound, Yet Profit-Taking Still Advised
The fundamentals of some technology stocks are still relatively healthy. Debt burdens, valuations, and capital intensity remain at comparatively stable levels.
However, BofA pointed out that most indicators have worsened since its analysis last November. "Free cash flow conversion has stalled, and investment-grade bond and equity issuance has increased," Subramanian said. "The buyback-to-market-cap ratio has slowed, and the capital expenditure-to-operating cash flow ratio for hyperscalers is expected to rise from 40% in 2023 to nearly 100% by the end of this year."
She added the view that opportunities still remain at the individual stock level. "Within the S&P 500 constituents, I see investment opportunities, but not for the market-cap-weighted index as a whole," she said.
BofA maintained its year-end S&P 500 target at 7,100. That is about 4% below the recent closing level of 7,406.
By contrast, there is also analysis that the S&P 500 will continue its upward trend as the AI tailwind persists. On the same day, Citigroup strategist Scott Chronert raised his year-end S&P 500 target to 8,100. The move reflects his judgment that AI-led earnings growth will push the index above the 8,000 level.
"The AI tailwind is fueling an anecdotal surge in fundamentals across related sectors," he said. "I am strongly convinced that strong corporate earnings (earnings beats) will continue through the end of the year."
However, he stressed, "I believe we are now in the middle stage of the current AI boom. The era of a bubble in which stock prices rise on expectations is over, and for stock prices to rise further, companies must actually generate enormous profits and prove their own worth."
