Bank of America Sees Strong Fundamentals Sustaining S&P 500 Despite High Valuations

Despite the S&P 500 index reaching its highest valuation levels in decades, Bank of America has expressed confidence that the robust fundamentals of enterprises could sustain the stock market even amidst high valuations. Savita Subramanian, the head of U.S. equities and quantitative strategy at Bank of America, noted that the S&P 500 index is statistically expensive in 19 out of 20 valuation metrics compared to historical averages. She cautioned that relying solely on valuation metrics would not provide a strong bullish case for the S&P 500 index. However, she pointed out that earnings revisions have turned positive, and the long-term recovery of U.S. capital expenditure is expected to support nominal growth and drive corporate profits.

Subramanian highlighted that the transition to asset-intensive business models could potentially erode the index's profit margins and price-to-earnings ratios. Despite facing higher interest rates, inflation, and policy volatility, the S&P 500 index has shown better-than-expected profit margins. This is attributed to enterprises gradually moving away from a "low-quality" growth model that relied on zero interest rates and globalization. Most industries maintain leverage ratios near historical lows, and the index has become more "asset-light" over the past few decades due to the increasing proportion of technology and healthcare sectors.

Subramanian warned of a new risk: several of the largest companies, including the "Big Six" of U.S. stocks excluding Tesla, are becoming more asset-intensive as they invest tens of billions of dollars in capital expenditures. Historical analysis by Bank of America shows that asset-intensive manufacturers typically have lower valuation multiples than innovation-driven companies that rely on research and development, due to higher fixed costs and slower growth prospects.

She suggested that if the current massive investment cycle in artificial intelligence can bring about transformative productivity gains, it could ultimately offset these concerns. Post-pandemic wage inflation has prompted enterprises to "do more with fewer people," and companies with lower labor intensity continue to outperform less efficient peers.

Additionally, Bank of America remains bullish on the financial sector and other "traditional economy" sectors, citing potential regulatory easing as a catalyst for further productivity gains. The bank's optimism is based on the expectation that a more favorable regulatory environment could boost productivity and drive economic growth, thereby supporting the performance of these sectors.