S&P 500 may rise 10% by end of 2024 amid worries that small-cap stocks ‘can’t hack’ higher rates, says BofA

“Companies that can’t hack a higher interest-rate environment,” and are burning through cash, have mostly “drifted” out of the S&P 500 through price decline, Savita Subramanian, BofA’s head of U.S. equity and quantitative strategy, said Monday during an online media briefing on its 2024 outlook for the U.S. economy and equity market. In her view, the S&P 500 has become a bit higher in quality as a result of such companies migrating lower in market capitalization.

The S&P 500 may keep moving higher in 2024 against the backdrop of a slowing U.S. economy, according to BofA. 

“We’re looking for a soft landing,” said Subramanian. Under that scenario, U.S economic growth is  “positive but below-trend,” according to BofA’s outlook report.

Meanwhile, earnings per share for the S&P 500 probably has already “troughed,” she said. BofA expects that the S&P 500’s EPS may increase next year to $235, the report shows.  

Subramanian said that BofA prefers the equal-weighted version of the S&P 500 to the Russell 2000
RUT,
partly due to concern over higher refinancing risk for the small-cap index. Many companies in the Russell 2000 don’t make money, she said. 

The market cap-weighted S&P 500 index, whose gains this year have been fueled by a group of seven megacap stocks, has jumped 18.5% in 2023 through Monday, far exceeding the Russell 2000’s 2.3% gain over the same period, according to FactSet data. 

Shares of the Invesco S&P 500 Equal Weight ETF
RSP,
which tracks an equal-weight version of the widely followed S&P 500 index, has climbed just 3.8% this year through Monday, FactSet data show.

The U.S. stock market is up this year as investors closely watch the Federal Reserve’s monetary policy, with BofA’s head of U.S. economics Michael Gapen saying during the media briefing that the Fed is now in the “hawkish hold camp” with respect to its benchmark rate.

The U.S. central bank has kept its benchmark rate at a target range of 5.25% to 5.5% since July, a 22-year high. That’s after the Fed aggressively raised rates to bring down high inflation. 

Peak rate and inflation volatility is probably “behind us,” said Subramanian. 

Gapen expects the Fed is done hiking rates and may start cutting them in June at a pace of 25 basis points per quarter, although the road to 2% inflation is “likely to be a long one” in absence of a recession, BofA’s outlook report shows.