Bank of America warns stagflation scenario will tank stocks, says keep buying energy shares
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Bank of America believes that there is a growing risk of a low-growth environment with high prices, making energy stocks the best investment. The bank’s strategists said in a note Thursday morning that stagflation, last seen in the U.S. in the late 1970s and early 1980s, is generating a “realistic worst case” scenario where the S & P 500 falls to 3,200, or another 18.4% from Wednesday’s close. The Federal Reserve continues to try and halt inflation through raising interest rates. This would reduce corporate earnings potential. The relative forward price of energy would indicate a potential 89% upside. This is in addition to the 33% implied upside using prices-to-book and 47% implied upside using operating cash flow. In a note, Savita Subramanian (Bank of America’s equity strategist and quant strategist) stated that Energy was the #1 screen in our tactical framework. Materials is next. China risks, however, was a stronger sector than commodity price inflation. [U.S. dollar]Materials face recession and high costs. Materials has just been made to lose weight due to China’s exposure as well as the transition from goods to service. Energy is still overweight, thanks to low US supplies, war and accelerating service demand. The April increase in consumer prices was 8.3%, while the rise in producer prices was 11%. In times of increasing inflation, commodities-related industries tend to perform well because the U.S. currency is cheaper making dollar-denominated assets attractive. From an investing perspective, energy is the only positive sector on the S & P 500 in 2022, rising more than 45% on soaring prices and expectations of persistent inflation for the next several years. Also, the conflict in Ukraine has contributed to oil and gas prices rising. Subramanian claimed that today’s market looks very similar to the dotcom bubble of 1999-2000. That time was characterized by the “acceptance and unthinkable”, which included negative real interest rate, as well as negative risk premiums. This is the return that investors are expecting on risk assets in comparison to government bonds. Even though interest rates have risen, Treasurys outperformed equities by a wide margin this year. Real rates have flipped to positive and we are now in rational territory. But don’t start the party yet: after the ERP flipped to positive in 2001, it took another 14 months for the S & P 500 to trough,” Subramanian wrote. Investors should keep an eye out for “recession risks” that are increasing while there is a growing scare.
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