Merrill Lynch Sees S&P 500 at 2,800 end 2018… With Some Risks

US equity market could continue its run next year with the risk that investors fall into euphoria.

Despite raising a number of questions about the fundamentals underpinning the last couple of years rallye, Bank of America Merrill Lynch’s strategist Savita Subramanian has a still bullish view, and even recommends to be overweight the Technology sector.

Here’s a summary of her team’s views:

What behind the 2,800 price target for S&P 500 ?

BofAML forecast an 6% EPS growth in 2018 to $139 from $131 (+11% in 2017). Ex-energy, earnings growth will slow next year to +6% (from +7%). Upside risk is seen in corporate tax reform, which was a huge driver in US equities run up during the first part of 2017.

Tax reform could add up to $19 to EPS next year (including $3 for repatriation-induced buybacks).

Downside risk to EPS: wage growth, which is already affecting some industries (retail, industrials).

Downside risk #2: end of QE and reduction in Fed’s balance sheet could remove a significant sentiment driver going forward.

Other risks: credit spreads widening, defaults/delinquencies in certain segments of the loan market (autos/credit cards/student loans) and of course due to a rise in interest rates.

Which sector allocation ?

Merrill has an overweight view on 3 sectors: Technology (momentum/long-term growth potential); Materials (inflation correlated, biased towards momentum and secular growth themes); Financials (leveraged to higher rates, tax reform and rebound in volatility).

The bank has a « Market-weight » view on Healthcare, Consumer staples, Industrials, Energy, Telecom and an Underweight view on Real Estate (worst performing sector in ending bull markets), Consumer discretionary (underperformer during rate hikes cycle) and Utilities (similar dynamics to Real Estate).

What history tells us about bear markets ?

The following table gives an overview on a number of indicators investors can look at.

Source: Bank of America Merrill Lynch

Goldman Sachs also did an indepth work on this subject a couple of months ago. We shall refer to that later on.

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The next table give a sector based view on EPS trends in the US equity market for the last 6 years + 2 years of forecast from Merrill.

Source: Bank of America Merrill Lynch