Savita Subramanian

The Federal Reserve is too friendly.

When the Fed ended its massive bond-buying program (or "QE3" quantitative easing) last October, the path looked clear for eventual interest-rate increases.

But because of stubbornly low inflation and concerns about global economic growth, the Fed has delayed raising rates, most recently last Thursday.

In a note to clients on Monday, Bank of America Merrill Lynch's Savita Subramanian writes that if "QE4" were to happen, it would tell markets that all the extraordinary monetary stimuli of the past few years has not been enough.

And this would be bad news for stocks:

We have noted that each incremental instance of monetary stimulus has been met with diminishing returns for risk assets. We think further easing, or a lack of tightening, in the U.S. is a negative for stocks. The expectation for Thursday's FOMC policy decision was a rate hike and dovish commentary, or no hike and hawkish commentary. Instead, the Fed left rates unchanged and delivered a dovish message. In response, the S&P 500 sold off into the close and was down the next day. As we have noted recently, the biggest risk to equities could be another round of QE—suggesting that $4.5tn was not enough to prop up the U.S. economy.Also, the read across for global risk assets could be that significant liquidity provided by central banks may not always be sufficient to drive markets higher.

Last week, Societe Generale's Kit Juckes told clients that as this era of so-called easy money that has supported asset prices wound down, all the buying that supported it was also waning.

And, according to Subramanian, "the Fed is helping so much it hurts."

SEE ALSO: The party's over

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Savita Subramanian

Bank of America Merrill Lynch has a big long-term call for the S&P 500: 3,500 by 2025.

This may seem like a big number, but with this call BAML is calling for a roughly 67% increase in the benchmark stock index over the next 10 years — the past six years have seen the index nearly triple.

The S&P was trading near 2,090 on Tuesday.

Now, many will note that the 2009 low was most likely a "generational bottom," or a point at which the market got far less expensive than any reasonable valuation warranted.

And so going forward, BAML is basically calling for less-than-stellar stock market returns that will, however, most likely be better than the alternatives.

Here's BAML's Savita Subramanian:

Based on current valuations, a regression analysis suggests compounded annual returns of 8% over the next 10 years with a 90% confidence interval of 4-12%. While this is below the average returns of 10% over the last 50 years, asset allocation is a zero-sum game. Against a backdrop of slow growth and shrinking liquidity, 8% is compelling in our view. With a 2% dividend yield, we think the S&P 500 will reach 3,500 over the next 10 years, implying annual price returns of 6% per year.

In its year-ahead outlook, BAML calls for the benchmark S&P 500 to climb to 2,200 by the end of 2016, a roughly 5% increase from current levels.

This call is still more aggressive than BAML's in-house "fair value" model of the market, which implies stocks will rise only 1% over the coming year.

And as for when the current bull market could get fully exhausted, Subramanian thinks there will be a major blow-off top before we can call for a regime change in the stock market.

"As we move further into this bull market, the dilemma many investors face is whether or not to maintain equity exposure," Subramanian writes.

Adding:

Performance of equity markets in the last few years preceding market peaks generally has been strong, with the minimum equity market returns achieved in the final two years of a bull market sitting at 30%, with median returns of 45%. Returns preceding the 1937 and 1987 peaks were particularly strong: 129% and 93%, respectively. And returns in the last two years of a bull market cycle have generally contributed over 40% of the total returns of the cycle. The lowest returns achieved in the last 12 months of a bull market were also a still-impressive 11%. These robust returns make the opportunity cost of selling too early potentially quite painful.

And so the core lesson: stay long.

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The stock market's price-earnings (P/E) ratio is probably the most popular and straightforward measure of stock market value out there.

When it's below some long-run average, the market is cheap. When it's about average, the market is expensive.

Unfortunately, just because stocks are expensive, it doesn't mean investors should immediately cash out and prepare for imminent price declines. Indeed, there are many studies that show that valuation tells you very little about what the stock market will do in the next year. But that doesn't mean valuations should be scrapped as a tool for investors.

"Our work suggests that valuation is a poor short-term timing indicator, but the single-most important determinant of long-term returns," Bank of America Merrill Lynch's Savita Subramanian said. "Valuations have historically explained 60-90% of subsequent returns over a 10-year horizon. Normalized P/E – our preferred valuation metric – has explained 80-90% of returns over the subsequent 10-11 years."

Subramanian tested the relationship between P/E and the 12-month returns using R², a statistical measure that reveals how well a regression line — the line of best fit you see — explains the relationship. The higher the R², the better job a P/E ratio does in explaining returns.

Bottom line: The longer your time horizon, the better valuations explain long-term returns.

cotd valuation This is not news. We've seen similar studies from BMO's Brian Belski, Citi's Tobias Levkovich, and others. But just because it's not news doesn't mean its not worth reiterating.

Subramanian and her team are confident that the S&P 500 will continue trending higher over the next 10 years:

Based on current valuations, a regression analysis suggests compounded annual returns of 8% over the next 10 years with a 90% confidence interval of 4-12%. While this is below the average returns of 10% over the last 50 years, asset allocation is a zero-sum game. Against a backdrop of slow growth and shrinking liquidity, 8% is compelling in our view. With a 2% dividend yield, we think the S&P 500 will reach 3500 over the next 10 years, implying annual price returns of 6% per year.

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Historically, the stock market has been able to deliver around 10% annual returns on average.

The key word when thinking about that, however, is "average." Rarely will you ever see the S&P 500 climb an even 10% in a given year. This 10% is determined by averaging years that have experienced returns much better than 10% as well as years that are much worse or even negative.

Ultimately, it's a mistake to think stock prices just go up, uninterrupted by downturns.

Bank of America Merrill Lynch's Savita Subramanian shared a chart that does a pretty nice job of illustrating the roller-coaster ride that stock market investors actually experience.

She reviewed 12 major S&P 500 peaks since 1930 and averaged the price performance during the months leading into the peak and the months after.

cotd sp500 performance around peaks

So as much as stocks tend to go up, they frequently also go down sharply. But those downturns are also followed by recoveries. And on net, the patient investor ends positive.

To be clear, this is just a summary of what has happened in the past around market peaks. In between these events are long periods of lackluster action in the markets. Having said that, there are a couple of things to take away from Subramanian's research:

Returns are very strong in the months leading up to a peak. The median returns in during the six months and 12 months before a peak were 14% and 21%, respectively. An investor seeking gains probably wants to be part of that action.
Declines after a peak are bad, but they don't offset the gains. The median returns in during the six months and 12 months after a peak were -12% and -15%, respectively.
But even after the violent sell-offs, markets recover losses in two years. The median return 24 months after a peak is -1%, meaning that most of the losses seen in the six-month and 12-month periods are recovered for patient investors. If anything, downturns are opportunities for investors to buy more and lower their average costs.

Attempting to time the market (i.e., trying to perfectly sell at the high and then buy at the low) is usually a money-losing proposition for investors and traders. But the history — for what it's worth — shows that patient investors will at least be able to recover losses as long as they don't sell at the bottom.

baml returns

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For 2016, Bank of America Merrill Lynch's Savita Subramanian likes "liquidity over leverage." Specifically, she's recommending to clients that they seek stocks of companies that are financially robust, not in financial distress.

Behind this call is her expectation that this current era of loose monetary policy and tumbling interest rates may be coming to an end, which would put more pressure on companies with low credit quality.

"[A]s liquidity dries up and rates rise, we believe companies with conservative balance sheets and ample capital cushions could fare much better," she wrote in her 2016 outlook for stocks. "These companies are best suited to survive downturns, can sustain or grow dividends, and can take advantage of depressed markets to purchase inexpensive companies or well-timed share buybacks."

During a presentation on Tuesday, Subramanian shared a chart showing how investors had actually been paying up for companies with low credit quality. She illustrated it by showing the history of the forward price/earnings (P/E) ratios of stocks with high-yield debt divided by the forward P/E ratios of stocks with investment-grade debt.

"Perversely, we've spent the last 20 years paying a premium for [the stocks of companies with] high yield debt," she said.

cotd high yield investment grade credit

This high-yield, or junk, bond market has been getting a lot of attention lately as credit spreads have blown out. And this pain has actually subtly manifested in the stock market.

"A re-rating is already in the works," Subramanian observed. "High yield (HY) stocks within the S&P 500 are trading a discount to their investment grade (IG) counterparts for the first time in two decades."

With monetary policy in the US expected to tighten during a time when interest rates are at their lowest levels in decades, Subramanian is suggesting to investors that it's time to throw out the old playbook.

"Our overarching theme for the next year, and for the next regime, is to do the opposite of what has worked during the last 30 years," Subramanian wrote. "The last 30 years was a period during which US interest rates were generally falling, and the US dollar was generally weakening. And since the Tech Bubble, we have seen unprecedented amounts of liquidity funneled into the capital markets, and highly-levered, credit-sensitive, smaller-cap and lower-quality stocks and sectors outperformed their more liquid, larger-cap, higher-quality counterparts.

"As we believe we are entering a new regime of slowly rising rates and a stronger dollar, what worked the last 30 years is unlikely to be leadership in the new regime."

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Savita Subramanian

The S&P 500's financials sector is the only one that did not see price-to-earnings multiple expansion during the past decade.
Its relative cheapness presents investors with a unique buying opportunity, according to Savita Subramanian, Bank of America's head of US equity and quantitative strategy.
"We think financials' re-rating may be in its early innings," she told Business Insider via email.
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The stock-market sector at the heart of the 2008 crisis remains unloved among investors when judged by a key valuation measure.

The sector is none other than financials, which comprises of banks, insurers, and other institutions that helped trigger the worst economic meltdown in a generation.

There is no doubt that financials have delivered impressive returns overall, thanks in part to post-crisis regulatory reforms. Since the bull market began in March 2009, the sector has gained nearly 447%, ranking it in fourth position.

But narrowing in on the sector's price-to-earnings multiple reveals that it has been uniquely undervalued over the past decade.

Savita Subramanian, Bank of America's head of US equity and quantitative strategy, recently shared the chart below with Business Insider. It shows that only financials saw P/E contraction over the past decade. And in her view, it reflects an opportunity for investors to get in on the ground floor of a relatively cheap sector.

Subramanian

"We think financials' re-rating may be in its early innings," Subramanian told Business Insider via email.

In tandem with the valuation advantage, Subramanian identified three catalysts that should benefit financials moving forward.

1. More stable earnings

The fourth-quarter earnings season provided a snapshot of how far financials have come since 2008.

Shortly after banks kicked off their earnings reporting in January, Subramanian pointed out that the consensus forecast for financial profits was the highest on the S&P 500.

As of March 2, analysts' expectation for 13.4% earnings growth from financials was bested only by utilities, data from Credit Suisse showed.

Subramanian also noted that the earnings results confirmed a solid consumer economy with no evidence of imminent credit risk — a far cry from the throes of the 2008 crisis.

2. A rotation into value

Much like the financials sector, value stocks that are beloved for their relatively cheapness have not been bid up to the stratosphere.

Throughout this bull market, there have been several breakouts in value stocks — including a sudden and violent rotation last July.

But Subramanian is among the strategists who see the record-low cheapness of value stocks relative to popular momentum names as an opportunity to buy.

And as this rotation to value occurs, financials should benefit.

3. Rising payout ratios with attractive cash returns

Companies that returned cash to shareholders via dividends earned a premium during the past decade, thanks to the scarcity of decent yields elsewhere.

Dividend payouts drove 64% of the S&P 500's multiple expansion in the 10 years through mid-January, according to Subramanian.

Problem is, the spigot may not get wider: the S&P 500 had a payout ratio (dividends paid relative to net income) of 42% versus its long-term average of about 45%.

However, financial companies were stragglers when it came to cash returns. Their payout ratio of 27% was below the pre-crisis average level of 36%.

This means unlike the broader market, there is room for financial companies to raise their cash payments back towards the historical average.

Investors who want to load up on the financials sector can gain broad exposure through exchange-traded funds like the Financial Select Sector SPDR Fund and Vanguard Financials ETF.

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Nearly 60% of all large-cap stock pickers bested their Russell 1000 benchmarks in the first quarter, Bank of America analysts said Friday, the best outperformance rate since the financial crisis.
The managers' wins came amid the worst first quarter for equities in history.
Managers focusing on large-cap growth stocks had the most winners in the period, with 64% of pickers outperforming the Russell 1000 Growth index.
Historically indiscriminate selling through the three-month period created an "abundant alpha opportunity" for active stock pickers, the team led by Savita Subramanian wrote in a note to clients.
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Despite stocks' worst first quarter in history, more than half of all large-cap fund managers beat the market.

Nearly 60% of all large-cap managers beat their Russell 1000 benchmarks during the turbulent quarter, Bank of America analysts said Friday, the best outperformance rate since the 2008 financial crisis. The average fund sank 19.5%, while the broad index tumbled 20.2%.

The group of managers focusing on growth stocks had the most winners through the first quarter, with 64% outperforming the corresponding Russell 1000 Growth Index. Value managers had the smallest proportion of winners and posted an average return slightly below the related index.

The average core fund beat its Russell 1000 equivalent by less than one percentage point, according to Bank of America. The Russell index is used as a broad market tracker and holds the largest 1,000 US companies by market cap.

BofA

Selling through the first three months of the year was the most indiscriminate in history, the team led by Savita Subramanian, creating "abundant alpha opportunity" for active stock pickers. Managers can also enjoy outsized diversification in which sectors to pick from, "given the uniform penalty for stocks during the sell-off," they added.

Small- and mid-cap pickers fared worse amid the coronavirus-induced volatility. Their outperformance rates were 43% and 44%, respectively, though growth managers outperformed in both categories, according to the bank.

Nearly all risk markets slipped through March as mounting coronavirus risks and strict containment measures drove mass rushing to cash and calls for near-term recession. Equities have since rebounded from late March lows as investors buy stocks at low prices and governments issue trillions of dollars in stimulus to avoid economic disaster.

Major US indexes rallied through Monday's session by roughly 5.5% on news of the virus's death toll slowing in Europe and the US.

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trader nyse pray

China's economy is beginning to heal following the coronavirus outbreak, and Bank of America says it's setting a blueprint for what industries and companies in the US can recover first from the domestic outbreak.
Strategist Savita Subramanian maes 12 stocks that operate in industries that could bounce back soon and look inexpensive.
She also named eight others that could be overpriced.
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Even as the US economy gets historically bad, investors are getting more optimistic about stocks.

They're betting on the eventual recovery, and Savita Subramanian — Bank of America's head of US equity and quantitative strategy — says that China is a major reason they're so hopeful. Its economy is starting to bounce back after the country got control of the coronavirus outbreak.

Ticker: MRO

Sector: Energy

Market Cap: $4.4 billion

2020 Performance: -58.9%

Source: Bank of America

chicago board options exchange female woman trader

Bank of America Merrill Lynch's proprietary sell-side indicator showed analysts were less optimistic about the stock market in May.
The market went on to gain 20% on a median basis when the indicator was historically at these levels, according to Savita Subramanian, the head of US equity and quantitative strategy.
She recommended two classes of companies that investors should buy for the gains ahead.
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Amid nationwide protests and the coronavirus pandemic, it is no surprise that some Wall Street strategists are advising investors to be more cautious with their money.

Bank of America has curated the sentiment contained in such advice since 1985 using its so-called sell-side indicator. It is based on the average equity-allocation recommendations of Wall Street strategists on the last business day of every month.

What the indicator has proven over the decades is that it often pays to go against your gut reaction to the news flow. And so when it feels like stocks should head lower, that's probably the right time to buy. After all, the market is still climbing steadily from its mid-March low despite all that is going on.

Warren Buffett perhaps demonstrated this idea best with his quote on being fearful when others are greedy and vice versa. His contrarian ethos is backed up by Bank of America's proprietary indicator, which is now suggesting that stocks are primed for gains in the year ahead.

In May, the sell-side indicator dipped slightly to 54.9 from 55.2, even as the market rallied. Investors were profiting from the rally but filled with uncertainty about how the economy will recover from its worst contraction of the post-war era.

Historically, this has been precisely the kind of environment to buy into.

"When the sell side indicator has been this low or lower, total returns over the subsequent 12 months have been positive 94% of the time, with median 12-month returns of +20%," Savita Subramanian, the head of US equity and quantitative strategy, said in a recent note.

The indicator is one of five inputs in Subramanian's S&P 500 target, which places the benchmark index at 3,419 (up 12%) over the next year. The index is still 9% away from its record high.

Besides the potential gains in the months ahead, Subramanian's big-picture takeaway from the indicator is that it remains stuck in "tepid" sentiment.

What's more, the thresholds for the indicator to scream "extreme" bullishness or bearishness have fallen. That's because the marketwide appetite for aggressive equity allocation never fully recovered after the Great Recession because of battered retirement assets and an ageing population that takes less risk closer to retirement.

This behavioral shift has two investing implications for the moment. First, it creates the opportunity to buy stocks with safe dividend yields at relatively cheap prices. At 2%, the dividend yield of the S&P 500 "is at a multi-decade record multiple of bond yields," Subramanian said. She previously singled out the financials sector as a place to find income-generating companies.

At the same time, the economic crisis has weakened the durability of dividends for many companies. For this reason, Subramanian advises buying quality companies with healthy balance sheets.

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Bank of America strategist Savita Subramanian on Monday raised her S&P 500 price target to 2,900 from 2,600 — and issued a "mea culpa" for missing the recent rally.
"Tepid sentiment is the more bullish input into our target; our Fair Value Model and weak estimate revisions are the most bearish," Subramanian wrote in the Monday note.
The bank isn't more bullish because of a number of potential downside risks it sees, including a potential second wave of COVID-19.
Read more on Business Insider.

Bank of America issued a "mea culpa" and hiked its target price for the S&P 500 after missing out on the market's most recent rally.

In a Monday note, Savita Subramanian, the bank's head of equity and quantitative strategy, raised its S&P 500 target to 2,900 from 2,600 and noted that the index's "meteoric ascent" has been helped by Federal Reserve stimulus.

Since March 23 lows, the S&P 500 has surged as much as 43%, the swiftest recovery from bear-market territory in history, fueled by "unprecedented fiscal and monetary stimulus" due to the coronavirus pandemic, according to the note. Tech stocks, or "secular growth/ stay at home" beneficiaries have led the rally, driven by the increased liquidity.

Screen Shot 2020 06 08 at 2.58.37 PM

"Tepid sentiment is the more bullish input into our target; our Fair Value Model and weak estimate revisions are the most bearish," Subramanian wrote in the Monday note. "US stocks remain expensive vs. history on most measures except for free cash flow, but attractive vs. bonds."

Currently, the S&P 500 is above Bank of America's target, suggesting that it's trading above fair value, according to the note.

Going forward, the bull case for US equities includes a V-shaped recovery, a COVID-19 vaccine, no second wave of the illness, and tepid sentiment and high cash allocations, according to the note.

On the flip side, Bank of America sees a number of downside risks to the S&P 500 target. Those include cyclically peaked 2019 earnings-per-share, risks of a second COVID-19 wave, US election risks, risks to a snapback in consumption and services, and borrowing from the future to fund today's growth.

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The shrinking premium of stay-at-home stocks over business-as-usual firms could mean the end of the S&P 500's reopening enthusiasm, Bank of America said Monday.
Quarantine plays including Zoom and FedEx commanded a 40% premium in March over firms slammed by the coronavirus pandemic. The market has since split the difference between the premium's pre-outbreak discount and March's peak.
"We think the market could be pausing, just like Texas and a few other states, in reopening optimism," the team led by Savita Subramanian wrote in a note to clients.
Such a halt would endanger the S&P 500's historically expensive valuation. The index is statistically expensive by all 18 metrics used by the analysts apart from equity risk premium and free cash flow.
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Stay-at-home stocks' premium over business-as-usual names suggests the market's hope for a swift economic reopening could soon pause, Bank of America said on Monday.

S&P 500 companies benefiting from stay-at-home orders and telecommuting vastly outperformed the market through March as stocks tumbled to their coronavirus trough. Names including Zoom, FedEx, and AT&T at one point commanded a 40% premium to companies particularly damaged by lockdowns, such as Gap and Carnival Corp.

That premium has since shrunk to largely split the difference between the pre-pandemic discount and the March peak. The market's unbridled enthusiasm for a rapid recovery may finally be giving way to spiking coronavirus case counts, the bank said.

"We think the market could be pausing, just like Texas and a few other states, in reopening optimism," the team led by Savita Subramanian wrote in a note.

Bank of America

Such a trend would likely pull the benchmark index from its lofty levels. The S&P 500 is statistically expensive by nearly all 18 metrics, Bank of America said, with just its equity-risk-premium and free-cash-flow readings showing the market as inexpensive.

The index is also still attractive to index investors for its healthy dividend yield, the team said. S&P 500 dividends sit at roughly three times the yield on a 10-year Treasury note, nearing a 70-year record.

For those looking to pick winners within the expensive index, Bank of America found healthcare stocks to provide the best quantitative positioning. Tech giants slid to second place in the firm's short-term list, as strong earnings forecasts and price momentum give way to high valuations.

The analysts also found opportunities for positive earnings revisions and momentum in semiconductor stocks, food products, and media services. Energy stocks ranked last in the bank's framework, and the bank warned against "value traps" that boast above-average prices alongside low-ranking price and earnings momentum.

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Wall Street

Mutual fund managers largely underperformed their benchmarks in July as macroeconomic focus blocked out stocks' dismal fundamentals, Bank of America said Thursday.
Large-cap active funds' hit rate was just 28% last month, its worst in two years, as managers failed to find names outperforming the market.
Managers largely ignored the month's best-performing sectors including consumer staples and utilities stocks, the bank said.
Growth strategies across small-, mid-, and large-cap funds outperformed core and value approaches as investors remained crowded in safer plays.
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Mutual fund managers faltered throughout July as neglected sectors posted unexpected gains.

Large-cap active funds' hit rate — the share of stock picks outperforming the broader market — reached just 28% last month, Bank of America said Thursday, its worst reading in two years. That comes despite stocks enjoying their best July since 2010. The average fund lagged its relevant benchmark index by 0.66%, and only 42% of managers are outperforming their benchmarks year-to-date, the team led by Savita Subramanian said.

The months-long tech rally slowed in July, leading other sectors to jump more than expected. Managers failed to pick many stocks in some of the best-performing pockets of the market, such as the consumer staples and utilities sectors, according to the bank. Both led the S&P 500 in its 5.5% July gain.

Managers expecting worse-than-expected economic data to drive a market slump were also flustered. A slowdown in consumer spending and hiring activity drove fears of a prolonged recession, yet indexes continued to creep higher on stimulus hopes. Correlations neared peak levels over the month, the analysts said, indicating a greater focus on macroeconomic trends than stocks' fundamentals.

Growth-focused managers across large-, mid-, and small-cap funds outperformed their value- and core-focused peers in July. Investors delayed a rotation to riskier value names as coronavirus cases spiked higher.

Still, only 20% of growth funds beat their benchmarks. Concentration in the Russell 1000 led active managers to mostly miss the market's best performers. While growth funds gained the most, value and core managers fared better in picking winning stocks in their respective fields.

Mid-cap funds notched their worst monthly performance since June 2016, with just one-fifth of managers outperforming benchmark indexes. Core funds in the category continued a streak of below-50% hit rates in every month this year.

Small-cap funds offered a less dismal July performance. Nearly three-quarters of all managers beat their respective benchmarks last month, and small-cap growth funds landed their best monthly performance in data going back to 2008, according to Bank of America.

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Wall Street coronavirus

Bank of America recommends value stocks over growth names as major indexes breach record highs, but warns that value traps could damage investors' portfolios.
Value traps are stocks that seem inexpensive but are more likely to continue falling than stage a comeback.
Bank of America searched for stocks with relative prices falling faster than their earnings, and found that real estate investment trust, telecom, and multi-utilities stocks screen as value traps.
Investors should pick high-quality names with strong price momentum and fundamentals within the value space, the bank's analysts said.
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Bank of America's analysts prefer holding value stocks over more expensive growth names, but see a handful of traps dotting the investing landscape.

Several gauges used by the bank identify the stock market as extraordinarily expensive. For one, the S&P 500 sits at record highs roughly five months after bottoming out on virus fears, despite the pandemic's economic damage still looming.

Stretched valuations across the market's darlings leave the best opportunities in value picks, the team led by Savita Subramanian said in a Tuesday note. However, certain inexpensive stocks pose a major threat to investors and should be avoided at current levels, they added.

The bank screened for companies and sectors that are inexpensive because relative prices are declining faster than their earnings. Though such stocks may seem like appealing buys at first, the analysts warn that their earnings deterioration can continue and leave investors with a rapidly depreciating asset.

Some sectors are fraught with traps specifically due to possible de-rating on pandemic-related risks, the team said, including real estate investment trusts. Others, such as telecom and multi-utilities stocks, have simply underperformed the broader market for too long, and generally need an external booster to drive shares out of their downward spiral.

The firm named KeyCorp, Prudential, Unum, and Welltower as just some of the value traps to be wary of due to below-median forward earnings, revision trends, and price momentum.

An easy way to separate the traps from the healthy picks is by screening for market quality, the analysts said. Traditionally cyclical sectors including autos, metals and mining, and semiconductors present strong value opportunities, the bank said, as their fundamentals and price momentum set them up for gains down the road.

Some of the bank's recommendations for "quality value" stocks include Microsoft, Alliant, Cisco, and Broadcom.

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Savita Subramanian

Bank of America's Savita Subramanian is one of the most influential strategists on Wall Street.
In an exclusive interview, she shared with Business Insider what has driven her success, which philosophers have guided her throughout her career, and her thoughts on market democratization.
Click here to sign up for our weekly newsletter Investing Insider.
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If you're a close follower of market news, you've probably seen Savita Subramanian on your television screen at one point or another.

The head of equity and quantitative strategy at Bank of America is a regular contributor to financial TV for good reason: She does some of the most influential work on Wall Street for one of the biggest investment banks. People care about what she has to say.

But odds are Subramanian isn't like many of the other analysts you might see making media appearances — or even generally similar to most people working in the numbers-heavy field of finance, for that matter.

Of course, Subramanian is well-versed in the quantitative side of things go — she has a mathematics degree from the University of California, Berkeley, and an MBA with a focus in finance from Columbia University.

But much of the time, she approaches her job from a different perspective — one rooted in the humanities.

While at Berkeley, from which she graduated in 1995, she also majored in philosophy. The decision still informs her work, sometimes more than her other fields of study.

"My math major is what got me in the door, but my philosophy major is what kept me here," she recently told Business Insider in an exclusive interview. "Philosophy basically helps you parse really complicated problems."

She added: "Financial markets are a human construct, and behavior, psychology, and all the 'softer' disciplines matter just as much as determining the value that investors are willing to pay for an equity."

The 'Nietzschean perspective' of data

Subramanian, who has been with Bank of America for 19 years, is clearly well-read. A fiction buff, her preferred genre is mystical realism, particularly the writings of Gabriel García Márquez. She and her husband trade books they think the other ought to read. On her plate now: Richard Rhodes' "The Making of the Atomic Bomb."

It's apparent that Subramanian also sharply retains her readings in philosophy. While she says many thinkers have shaped her paradigm, two philosophers have stuck with her the most throughout her career.

One of them is Ludwig Wittgenstein, who is known for his works on how language shapes our perceptions of reality — and how reality is only a product of how we perceive it.

"That's really been helpful to me in thinking about the markets," she said. "Sometimes it's not about the underlying earnings, but it's about the perception of a stock or an investment that can actually create its own trading pattern."

The other philosopher is Friedrich Nietzsche, a German who lived until 1900.

"His whole doctrine is you should constantly be questioning your assumptions and constantly be willing to reject your assumptions in favor of a better theory," Subramanian said.

She added: "If you have a thesis about a stock or about the market, you can basically find data that will support your thesis. But instead, I think, the better way to approach this is the more Nietzschean perspective — to look at all the data and get rid of all your assumptions and see what would be the more intellectually honest thesis."

Making markets more accessible

While Subramanian aligns herself with Nietzsche for his avant-garde ideas on the nature of truth, perception, and skepticism, she seems to differ from the iconic thinker in some ways.

Nietzsche is perhaps history's most famous nihilist — someone who thinks nothing in the world or in one's life has any meaning and tends to therefore be pessimistic.

Subramanian appears to categorically reject this stance, at least when it comes to finding meaning in her work. She heads up her firm's environmental, social, and governance investing, or ESG — a framework for gauging the corporate impact of issues like climate change and diversity.

"What we're trying to do is basically draw a linkage between treating your suppliers and buyers and customers fairly and actual economic value add — so proving that linkage, I find to be super satisfying," she said.

She also exudes a passion for making investing more accessible. Only 55% of American adults own stock, according to a June Gallup poll of about 2,000 people — a statistic related to income levels.

"It would be nice to democratize the market and make investing not just something people with MBAs who all went to the same school and have parents who were investors" do, Subramanian said.

She also applauded how exchange-traded funds and online retail brokerages have increased market participation.

"Taking arcane concepts and breaking them down in a way that's accessible to everyone — it's a satisfying feeling making the markets more transparent and accessible," she said. "Probably one of my favorite parts of the job is talking with financial advisers and individual investors because I feel like there you get an opportunity to really make a difference."

Subramanian also talked about the need to continue dismantling structural and cultural barriers that have led to women investing at a lower rate than men, and men making up a higher percentage of finance professionals.

"There was always the quintessential person in finance, and it was somebody who was middle-aged and went to an Ivy League school, mostly male and mostly white. And it made me feel really out of place," she said. "But then it almost made me feel even more bent on proving that I could do it and be good and be better."

'You want to leave a mark on the world'

Subramanian, who was hired by Richard Bernstein in 2001, climbed the ranks to management over her nearly two decades at Bank of America.

In addition to a desire to prove that a woman could be successful in finance, Subramanian said the way she's wired has been another driver behind her career's trajectory.

"It's kind of this personality trait that I have where I'm — dissatisfied sounds too negative — but I think I always want to get to the next thing," she said.

"Ever since I was little, when we got assigned a book, I just wanted to read it really fast and get to the next thing," she said. "It's a weird way to live. I don't know if it's a good way to live or a bad way, but I think it's kept me on this path moving forward as fast as I can."

In adulthood, Subramanian is driven by something else: the desire to leave a mark, to allow for posterity to stand on her shoulders — like Wittgenstein and Nietzsche have done for her.

"I didn't feel like this when I was younger but now I do," she said. "I feel like you want to leave a mark on the world where people who come after you can learn from what you've done and build on it."

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Trader worried

Investors risk losing out big if they try to time the market instead of holding through today's volatility, Bank of America strategists led by Savita Subramanian said Thursday.
Missing out on the market's 10 best trading days per decade since the 1930s means the difference between a portfolio gaining 17% over the period or surging 16,166%, according to the team.
Staying invested through turbulent price action "can help recover losses following bear markets" faster than rapid-fire day trading, they added.
The bank recommended staying put in high-quality stocks, particularly firms with healthy balance sheets.
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Even with market volatility at historically high levels, investors should hold steady and avoid the urge to time stocks' price swings, Bank of America said Thursday.

It's an age-old investing adage: "Don't time the market." Yet turbulent price action and slashed trading fees fueled increased day-trading activity throughout the pandemic as investors looked to capitalize on Federal Reserve relief and the US economic recovery.

Those trying to trade stocks at a rapid-fire pace are likely to miss out on the market's best gains, the team led by Savita Subramanian said in a note to clients. If an investor missed out on the 10 best trading days per decade since the 1930s, their returns would total just 17%. Had they stayed in the market, their portfolios would've swelled by 16,166%, the team said.

"Market timing is difficult: the S&P 500's best days generally follow its worse days," the strategists wrote. "Remaining invested during turbulent times can help recover losses following bear markets."

It takes an investor roughly 1,100 trading days to recoup losses after a bear market, they added. Missing this year's rally out of bearish territory would be more detrimental than usual, as the record-speed slump in late February and early March was met with a similarly rapid surge back to historic highs.

The S&P 500 and Nasdaq composite now sit at record highs after riding tech giants' rally through the summer. The Dow Jones industrial average is hot off of erasing its 2020 losses.

For those who entered too late to enjoy the stock market's return to pre-pandemic highs, there's still opportunity in high-quality names, Bank of America said. The strategists recommended stocks with healthy balance sheets, as those firms are best positioned to ride out any spike in volatility or negative economic surprise.

They also trade near record underweight levels to the average active stock fund, the team said, making them one of the few corners of the market still ripe for new inflows. While "financial theory tells us quality should trade at a premium," the stocks continue to trade at a discount to their lesser-quality peers, the strategists added.

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Stock-pickers trimmed overweight bets across nearly all sectors but piled further into communication-services companies in recent months, Bank of America said on Wednesday.
The cutting-down of most outsized positions comes as managers prepare for the 2020 US presidential election to drive outsized market volatility, Savita Subramanian, head of US equity and quantitative strategy at the bank, said.
Both hedge funds and long-only funds either increased their overweight stakes in the communications services sector or maintained heavy positioning.
Some of active funds' most concentrated communications stakes include News Corp, Discovery, and Fox, according to Bank of America.
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Active fund managers are balancing positioning in nearly all sectors but one as election-fueled volatility nears, Savita Subramanian, head of US equity and quantitative strategy at Bank of America, said Wednesday.

After stocks' summer rally and recent slump, active managers neutralized extended bets as election uncertainty formed "a potentially murkier backdrop" for risk assets, the strategist wrote in a note to clients. Hedge funds hold equal exposure to cyclical and defensive stocks after hitting a record gap between the two categories in April. Long-only funds reversed their months-long move to cyclical stocks.

Yet stock-pickers turned increasingly overweight in their favorite sector. Both hedge funds and long-only funds are the most concentrated in communication services shares, with News Corp, Discovery, and Fox among managers' favorite picks. Managers either increased their weight in the sector or flat-lined, "indicating still high conviction in 2020's narrow leadership," Subramanian said.

The share of managers overweight in tech stocks also increased from levels seen in February, though relative exposure versus benchmark indexes slightly declined. Managers grew less exposed to consumer discretionary stocks but a slightly larger proportion of stock-pickers turned overweight in the group.

Once a strong contrarian indicator, fund positioning has taken on a more positive stance in 2020. More funds own tech and less own energy, tracking closely with broader market moves in recent weeks. Long-only managers' boosted stakes in real estate, consumer discretionary, and utilities stocks served them well, Bank of America said, as did their selling of energy, industrial, and financial equities.

Long-only funds' positioning in FANG stocks — Facebook, Amazon, Netflix, and Google-parent Alphabet— relative to the S&P 500 slid over the summer after climbing throughout last year.

Still, tech mega-caps' dominance in recent months hasn't driven bets against the group. Short interest in FANG names tumbled to record lows of below 1% of shares floated in August, according to the bank.

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After months of carefully playing defense, the world's biggest investors are finally comfortable betting on the US economy again.

Not surprisingly, hedge funds did not want part of anything exposed to the US economy when that economy was being hammered by the COVID-19 pandemic. They wanted shelter from the storm. But as the recovery has played out, Bank of America Head of US Equity & Quantitative Strategy Savita Subramanian says they've adjusted.

"Hedge funds, which hit the lowest levels of cyclical versus defensive exposure in April of this year, neutralized this bias to equal exposure to both cohorts," she wrote in a note to clients.

She illustrates that point with this chart, which shows hedge funds dramatically underweighting stocks in cyclical parts of the market compared to defensive stocks early this year as the downturn set in — and then snapping back to normal by the beginning of August.

Hedge fund positioning

More specifically, she says, long-only funds — the ones betting on stocks — have made big increases in their real estate and consumer discretionary holdings while selling defensive utility companies. They're not all-in on cyclical sectors, though, as they've also reduced their exposure to banks and energy and industrial companies.

"Most of these sector shifts have served fund managers well," Subramanian wrote. "The ten most overweight stocks outperformed the most underweight stocks by 19.2% YTD, the highest spread in a decade — where in most years, crowded stocks have lagged their neglected peers."

Subramanian's colleague, US equity strategist Jill Carey Hall, says that's only the latest sign that economically exposed stocks are looking more appealing.

"In tandem with hedge funds closing their defensive vs. cyclical bias this past month (where we have found that HF positioning changes have been positive indicators), our tactical quantitative work has grown increasingly positive on cyclicals," she wrote.

Carey Hall says that she's identified nine areas of particular opportunity, scoring them based on a combination of price momentum, positive earnings revisions, and favorable valuations.

She says the most attractive sub-industry is household durables stocks, which have the strongest momentum and earnings trends and better-than-average valuations. Those companies include homebuilders like D.R. Horton and companies that make long-lasting household goods like Garmin.

Automakers GM and Ford take second place in Carey Hall's rankings because of major earnings revisions and good trends in her other two categories.

HOW TO INVEST: In addition to buying the stocks individually, traders can get access to Carey Hall's consumer-related themes using ETFs like the iShares US Home Construction ETF or a broader fund such as the Vanguard Consumer Discretionary Index Fund, which would include most household durables companies.

While she's evaluating US companies, investors can get global exposure to automaker trends with funds like the First Trust Nasdaq Global Auto Index, while those who want a longer-term and more tech-oriented bet can try a fund like the Global X Autonomous & Electric Vehicles ETF.

Further down Carey Hall's rankings come metals and mining companies like Newport Mining, companies that sell industrial equipment, including Fastenal, interactive media and services names such as Facebook and Alphabet, and general merchandise distributors like Genuine Parts.

She adds that media companies like Comcast and Charter have fairly high valuations but good price and earnings data, while semiconductor companies and chip equipmentmakers like Applied Materials and AMD have excellent price momentum, and slightly less favorable scores in the other two metrics.

Finally, general retailers like Dollar General have good earnings trends but don't rank as high in valuation or price terms.

Carey Hall also advises investors to watch out for value traps, a group of industries that have favorable earnings revisions but lack price and valuation momentum, which could consign them to frustrating returns.

She says the biggest traps today are in healthcare technology, diversified telecom, communications equipment, diversified consumer services, industrial conglomerates, equity REITs, real estate management, and broad-based utilities.

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Bank of America's Sell Side Indicator — which tracks Wall Street's bullishness toward stocks — rose to 56% in September, its highest since the coronavirus pandemic began.
The reading signals an 11% gain for the S&P 500 over the next 12 months, the team led by Savita Subramanian said.
In past instances when the gauge sat this low, returns over the next year were positive 94% of the time, they added.
Past election seasons also saw sentiment usually increase in November and December, according to the bank.
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After months of virus fears, record-breaking rallies, and unprecedented stimulus, Wall Street's outlook for stocks is back to its pre-pandemic norm.

Bank of America's Sell Side Indicator — which measures stock bullishness among Wall Street strategists — climbed to 56% in September, its highest since the coronavirus crisis began. The gauge latest reading sets a 12-month S&P 500 target of 3,734, implying an 11% return for the benchmark.

The reading remains in the same "neutral" territory it entered in 2016. The bank's "buy" threshold, fell slightly to 51.4%, while the level when it recommends selling shares fell to 60.7%.

Bank of America's indicator has a strong record of forecasting near-term market gains. In past instances the gauge sat so low, returns over the next 12 months were positive 94% of the time, the team led by Savita Subramanian said. The median 12-month return in said instances is 20%.

The indicator's uptick comes as investors and strategists alike gird for election-season volatility. Though several firms warn that delayed election results could keep markets frothy for weeks, precedent suggests the months immediately before and after the election will see sentiment turn even more optimistic.

In the eight previous election seasons, sentiment improved in 75% of Octobers, 63% of Novembers, and 50% of Decembers, according to the bank.

However, the trend could spell out a bearish swing should the coronavirus prolong an outcome. The S&P 500 sank roughly 5% in 2000 between election day and when the Supreme Court decided on the race in December. With President Donald Trump hinting he'll contest a Biden victory, a similar plunge could emerge in the final months of 2020.

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NYSE traders

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Stocks just closed out their best third-quarter performance in a decade, but Bank of America expects growth stocks to soon take a back seat to value names.
The Russell 1000 Growth Index opened a 36 percentage-point lead over its value-focused peer on Thursday. That's the biggest outperformance for growth stocks in data going back to 1979, Bank of America said in a note to clients.
Still, investors' heavy concentration in growth sets value up for a bounce-back. The bank recommended high-quality value stocks to ride out election-season volatility and the US economic recovery.
Positioning, valuation dispersion, and "an expected recovery in the profits cycle" point to a near-term rally for value, the team of strategists led by Savita Subramanian added.
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The stock market is hot off of its best third-quarter performance in a decade, and growth names are set to dominate through the rest of the year.

Though stocks sank through the start of September, the S&P 500 still notched a 9% gain in the quarter ended Thursday. Mega-cap stocks such as Apple, Microsoft, and Amazon are on track to post their best year since 1998. Further down the size spectrum, the Russell 1000 outperformed its mid-cap and small-cap peers in the third quarter.

The strong performance proved the "no alternative to stocks" argument is going strong, Bank of America strategists led by Savita Subramanian said in a note to clients. Even after volatility climbed in September, long-dated Treasurys and investment-grade bonds only gained 0.2% and 1.7%, respectively. Gold was on track to beat the S&P 500's return before falling 3.6% in September.

Within stocks, large growth names have been the clear favorite in 2020. The Russell 1000 Growth Index was up 24% year-to-date on Thursday, trouncing the corresponding value-focused index by 36 percentage points. That lead was the largest in Bank of America data going back to 1979.

The outperformance was largely fueled by strong momentum heading into the third quarter, the bank said. Despite serving as an early favorite through the coronavirus pandemic, the tech sector finished the quarter in fourth place out of the S&P 500's 11 groups. Consumer discretionary, materials, and industrials led the three-month upswing.

Still, value stocks will soon have their spot in the limelight, the strategists said. Though growth names still enjoy support from Federal Reserve policy, the bank recommended high-quality value stocks to ride out election uncertainties and lingering virus risks. The economic recovery continues to aid value's rebound, the team said. Market volatility will likely intensify in the weeks heading into the election, making higher-quality equities investors' best bet.

Despite September bringing a small rotation into value, the group has "more room to run," Bank of America said. "An expected recovery in the profits cycle, positioning, our [dividend discount model], and valuation dispersion all favor value over growth."

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An unusual trend has emerged in the current earnings season that hasn't been seen since the early-2000s tech bubble, Bank of America said in a Monday note.
Companies that beat both profit and revenue estimates are underperforming the most in history, while those missing expectations are outperforming the most in history, according to the bank's analysts.
The "perverse reactions" could be "a harbinger of a market dip" akin to that seen when the tech bubble burst, they added.
The lack of alpha could be tied to traders pricing in earnings and paying more attention to macro trends and the upcoming presidential election, the bank said.
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Public companies are posting unusually strong quarterly figures, but the market's reaction has been far from consistent.

Roughly 37% of S&P 500 firms have reported third-quarter earnings so far, with another 40% set to report this week. Nearly seven-in-10 companies have beaten expectations for both revenue and profit, handily exceeding the 40% average share, according to Bank of America data. The figure also represents the strongest second-week earnings performance in data going back to late 2011.

Yet the market has been rife with "perverse reactions" to the largely encouraging reports, the bank's analysts said. Earnings beats this season have underperformed the S&P 500 by 0.05 percentage points, the worst in history. Conversely, earnings misses are, on average, outperforming by 0.6 percentage points, the highest in history.

The reactions "smack of the tech bubble," the only other period with a similar degree of awkward post-earnings price swings, the team led by Savita Subramanian said. The market famously slumped after the unconventional earnings season, suggesting today's trend may be a "harbinger of a market dip," they added.

The analysts peg the atypical reactions to most earnings news already being priced in. Alpha from beats sits at 63%, signaling that macroeconomic factors and the upcoming presidential election overshadowed better-than-expected earnings, according to Bank of America.

Macro trends aside, companies guided for an extraordinarily encouraging end of the year. Bank of America's three-month guidance ratio, which tracks bullish versus bearish forecasts, climbed to a record 3.8x through the week. Its three-month earnings revision ratio leaped to its highest level since 2018. The share of above-consensus guidance reached its highest point in a decade, a stark reversal from recent quarters' lack of formal estimates.

This week is set to shift earnings reactions into a higher gear, with growth giants including Apple, Amazon, and Facebook all set to report. With mega-cap tech stocks holding a disproportionate weighting in major indexes, any misstep can add volatility to an already choppy pre-election trading week.

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