According to a report from Bank of America (BofA), the S&P 500 appears overvalued based on 19 out of 20 valuation metrics, signaling limited long term growth potential for the index. BofA’s analysis, using Price to Normalized Earnings as a predictive metric for 10-year returns, forecasts an annual price increase of just 1-2% over the next decade.
In contrast, the equal weighted S&P 500 index where each stock has equal influence projects a slightly stronger return of around 4-5%, suggesting better prospects for smaller stocks compared to the largest firms.
“This valuation trend isn’t new,” noted BofA strategists, led by Savita Subramanian, who pointed out that since July, the equal weighted S&P 500 has traded at a historic discount to the more common cap weighted version. This disparity indicates the potential for the average stock to achieve a 4-5% return over the next ten years.
Dividend contributions also remain key to overall returns. While dividends represented just 16% of total returns over the past decade, historically, they accounted for about 40%. If dividends were to return to this level, the S&P 500’s total return could see a significant rise, especially if dividends are reinvested. BofA projects that, with reinvested dividends, the equal weighted S&P 500’s total annual return could reach 8.3% over the next decade.
Additionally, two companies from the “Magnificent 7” recently started paying dividends, which may indicate further growth in dividend yields, potentially offsetting low price returns.
BofA also points out a shift in the corporate landscape, with today’s market increasingly favoring companies that are asset light, labor light, and debt light. This evolution may justify higher valuation multiples compared to historical norms, partly explaining the current high valuations.
Despite these dynamics, BofA remains cautious, noting that substantial price returns are unlikely unless inflation drops significantly. However, total returns adjusted for inflation are still expected to outpace the real yields of 10-year Treasury bonds under the current economic conditions.
