- Over the next decade, expect the S&P 500 to trade 45% higher from current levels to 5,200, Bank of America said on Thursday.
- BofA prefers stocks over other asset classes for the long term, but notes it is neutral to negative on stocks in the near term.
- BofA is cautious on stocks due to potential policy missteps from Washington, D.C., a potential resurgence of COVID-19, and uncertainty surrounding the election, according to the note.
- Bank of America raised its year-end price target 8% to 3,250, representing downside potential of 9% from Wednesday's close.
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Investors should continue to bet on stocks for the long term, but be prepared for volatility in the short term, Bank of America said in a note published on Thursday.
The firm expects the S&P 500 to trade to 5,200 over the next decade, representing potential upside of 45% from Wednesday's close. BofA's earnings model suggests stocks will generate annual price returns of 3% to 4% over the next 10 years, with an additional 2% in dividend returns boosting stocks' annual total return range to 5% to 6%.
While a 5% to 6% average annual return on stocks for the next decade would be well below the historical average S&P 500 return of 8%, it is still likely to outperform fixed income, BofA said.
In the short term, BofA is less bullish on stocks, and instead is "neutral to negative" due to potential policy missteps out of Washington, D.C., a potential resurgence of COVID-19, and uncertainty surrounding the upcoming presidential election.
The firm raised its year-end S&P 500 price target 12% from 2,900 to 3,250, which represents downside potential of 9% from Wednesday's close. BofA's drive to raise its year-end price target is derived from lower interest rates for longer given the Fed's recent inflation policy overhaul, and better-than-expected S&P 500 earnings.
In a worst-case scenario that includes a double-dip recession, the S&P 500 could trade down 39% to 2,200, BofA said. Meanwhile, a best case scenario that includes a COVID-19 vaccine, low interest rates, and more stimulus could drive the S&P 500 12% higher to 4,000.
In the event that a successful COVID-19 vaccine is developed and released, expect it to be "really bullish," but for other benchmarks than the S&P 500. "In a full COVID-19 recovery scenario, which would favor cyclicals, the S&P 500 could meaningfully lag other markets," BofA said.
While valuations are stretched on virtually all measures except when compared to bonds, in the short term, that doesn't matter so much for stock prices, especially with abundant liquidity, according to BofA.
"Valuations may not drive short-term returns, but explain close to 80% of the S&P 500's returns over a 10-year time horizon," BofA said.
In the end, investors who can afford a long time-horizon should continue to buy stocks. "The probability of losing money in stocks meaningfully drops as time horizons extend," BofA concluded.
