High valuations are not a problem! Bank of America: Strong corporate fundamentals are expected to support U.S. stocks
Despite the S&P 500 index valuation being at its highest level in decades, Bank of America believes that strong corporate fundamentals may support stock market performance. Savita Subramanian pointed out that corporate earnings expectations have turned positive, and the recovery in capital expenditures will drive corporate profits. Despite facing high interest rates and inflation, the S&P 500 index profit margins have outperformed expectations, mainly due to companies moving away from low-quality growth models. She warned that some large companies are becoming more asset-intensive, which may impact profit margins, but investments in artificial intelligence could lead to productivity improvements
According to the Zhitong Finance APP, despite the S&P 500 index being at its highest valuation in decades, Bank of America states that corporate fundamentals are stronger than in many years, which may help support stock market performance despite high valuations.
Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, noted that compared to historical averages, the S&P 500 index shows "statistically expensive" readings on 19 out of 20 valuation metrics, making it difficult to build a strong bullish argument for the S&P 500 based solely on valuations. However, she pointed out that corporate earnings expectations have shifted to a positive outlook, and the long-term recovery of U.S. capital expenditures is expected to support nominal growth and drive corporate profits. She highlighted the concern that the shift towards asset-intensive business models may erode the index's profit margins and price-to-earnings ratios.
Despite facing high interest rates, inflation, and policy fluctuations, the profit margins of the S&P 500 index have performed better than expected, thanks to companies gradually moving away from the "low-quality" growth model reliant on zero interest rates and globalization. Leverage ratios in most industries remain close to historical lows, and as the technology and healthcare sectors increase their share, the index has become more "asset-light" over the past few decades.
Savita Subramanian warned that an emerging risk is that several of the largest companies, including the "Big Six" of U.S. stocks excluding Tesla (TSLA.US), are becoming more asset-intensive as they invest billions in capital expenditures. Historical analysis from Bank of America shows that the valuation multiples of asset-intensive manufacturers are typically lower than those of R&D-driven innovative companies, as the former have higher fixed costs and slower growth prospects.
She stated that if the current massive investment cycle in artificial intelligence can lead to transformative productivity gains, it may ultimately offset these concerns. Post-pandemic wage inflation has prompted companies to "do more with fewer people," and companies with lower labor intensity continue to outperform their less efficient peers.
Additionally, Bank of America remains optimistic about the financial and other "traditional economy" sectors, as potential regulatory easing could serve as a catalyst for further productivity enhancements
