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Why the Bear Market Hasn't Yet Bottomed: Bank of America

After the S&P 500 slid 23% from the start of the year through June 16, the index has bounced back 17%.
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After the S&P 500 slid 23% from the start of the year through June 16, the index has rebounded 17%. This has many investors saying that the bear market is over and that the rally is here to stay. 

Not so fast, say Bank of America strategists.

“Only 30% of our bull-market signposts" -- things that happen before a market hits bottom -- "have been triggered, versus 80% in prior market bottoms,” they wrote in a commentary. 

That “suggests another pullback is likely.”

The strategists said that “one signpost with a perfect track record [since 1935] is the Rule of 20.” 

During that period, the sum of the changes in the consumer price index from a year earlier plus the market’s trailing price-to-earnings multiple was always less than 20 at the bottom of a market.

To bring the signpost current: In the 12 months through July, the CPI soared 8.5% and the S&P 500’s trailing p-e multiple recently stood at 21.6. That adds up to 30.1, well above the threshold of 20.

A Distant Barrier

“Outside of inflation falling to 0%, or the S&P 500 falling to 2,500 [from 4,274 recently], an earnings surprise of 50% would be required to satisfy the Rule of 20,” the strategists said. But the consensus forecast for earnings growth next year stands at 8%, and “we think that’s unachievable,” the strategists said.

Another Bank of America signpost: 

Another Bank of America signpost: On an enterprise-value-to-sales basis, where sales should be elevated higher consumer prices, the market multiple is excessively elevated (plus 40%) relative to history,” the strategists said. That’s “possibly because real sales growth [excluding] energy is essentially flat.” That would reduce the sales segment of the multiple.

One point that isn’t part of the Bank of America report: The biggest bearish factors for the market may be inflation and the Federal Reserve’s interest-rate hikes. Inflation could damp consumer spending, and the rate increases could weaken the economy, depressing corporate earnings.

On the bullish side, the Fed has said that at some point it'll slow its rate increases, and the central bank may well shrink their size as soon as next month. Meanwhile, roaring inflation hasn’t eliminated consumer-spending growth.

B of A Picks

If you are going to buy stocks, Bank of America’s short-term sector rankings put energy No. 1 for the 14th straight month, followed by industrials, “a classic capital expenditure beneficiary,” the strategists said.

Capital spending "may be more of a necessity amid a tight labor market warranting automation and [because of] deglobalization,” they said. “Capex should hold up better than in prior recessions.”

The investment bank ranked consumer staples and consumer discretionary last. But “consumer staples could hold up better than discretionary amid recession concerns plus food scarcity,” the strategists said. 

In addition, “the sector is deeply underweighted by active equity investors.”