BofA's Savita Subramanian says she sees too much euphoria in a popular market group

Key Concepts

• Market Broadening: The shift in market performance from being dominated by a few large-cap stocks (particularly in tech) to a more widespread increase in value across different sectors and market capitalizations (small caps, equal-weighted indices).
• Consumer Staples: Companies producing essential goods (food, household products) – identified as an undervalued sector with potential for growth.
• Capex (Capital Expenditure): Investments made by companies in fixed assets like property, plant, and equipment – seen as a driver of future market performance.
• Sentiment Analysis: Assessing investor attitudes and expectations towards the market, using models like the one developed by Rich Bernstein at Bank of America.
• Nominal GDP & Real GDP: Nominal GDP is GDP measured at current market prices, while Real GDP is adjusted for inflation.
• AI Impact on Labor: The potential displacement of white-collar professionals, particularly recent college graduates, due to the increasing capabilities of Artificial Intelligence.

Market Outlook & Sector Positioning – Savita Subramanian Interview

The interview with Savita Subramanian, Head of U.S. Equity and Quantitative Strategy at Bank of America Securities, centers on the current market environment, potential risks, and strategic positioning for investors. The discussion unfolded after a relatively uneventful trading day, punctuated by after-hours earnings reports from megacap companies.

Market Dynamics & Broadening Participation

Subramanian highlights a significant trend: the market is broadening beyond its concentration in technology and AI stocks. Specifically, the S&P Equal Weighted index is outperforming the Cap Weighted benchmark, and small-cap stocks are showing renewed strength. This broadening is occurring despite continued focus on the tech sector and AI. She notes this dynamic is often overlooked in market commentary.

Midterm Election Year & Policy Implications

The speaker emphasizes the importance of recognizing that 2024 is a midterm election year. She observes a shift in the current administration’s rhetoric, moving away from solely focusing on trade policy towards prioritizing affordability and domestic issues. This shift is expected to positively impact sectors that have historically struggled, particularly Consumer Staples.

Consumer Staples as an Out-of-Consensus Bullish Call

Consumer Staples is identified as Bank of America’s most “out of consensus” bullish overweight position. Despite recent concerns stemming from Amazon’s grocery announcements, Subramanian believes the sector is pricing in excessive negativity. She posits that a potential lifeline for lower-income consumers, coupled with supportive policy signals, could drive significant gains in this sector. The rationale is that if the consumer cohort most impacted by inflation receives support, demand for consumer staples will increase.

Shift from Consumption to Capex & Manufacturing

Subramanian argues that the stock market is now more likely to be driven by Capex (Capital Expenditure) and manufacturing growth rather than consumer spending. She expresses concern about the sustainability of consumption growth, particularly given challenges faced by recent college graduates entering the workforce.

Labor Market Concerns & AI Disruption

A key concern raised is the slowdown in hiring for white-collar professional services roles, traditionally a major driver of consumption. Recent college graduates are increasingly returning to graduate school, accumulating debt, and still facing difficulty securing employment. This is attributed to the increasing capabilities of AI, which can now perform tasks previously handled by entry-level professionals. This creates an “air pocket” in demand for skilled labor.

Sentiment & Historical Context

Subramanian acknowledges a past bullish call in June 2023 (when the S&P was at 4300) that didn’t fully materialize. However, she points out that market sentiment has significantly shifted since then. Bank of America’s sentiment model, originally developed by Rich Bernstein in the 1980s, currently indicates that sentiment is not yet euphoric, suggesting potential upside. She contrasts the current environment – a booming economy with accelerating earnings growth and near-2% inflation – with the recessionary fears prevalent in 2023.

Impact of Interest Rates & the Ten-Year Yield

The discussion explores the potential impact of interest rate movements. Subramanian believes that rising rates, particularly on the ten-year Treasury yield (potentially reaching 5%), would be beneficial for market broadening. She argues that higher long-term rates are more detrimental to mega-cap growth companies, which previously relied on cost-cutting, buybacks, and reduced Capex to offset the impact of higher rates. However, in the current environment of an “arms race” in AI, cutting Capex is becoming increasingly difficult.

Tech Sector Vulnerability & the Capex Cycle

Subramanian suggests that the tech sector may underperform in the coming year, as rising rates could constrain its growth. She highlights that in 2023, tech companies responded to higher rates by cutting Capex and implementing cost-cutting measures. However, the current focus on AI investment makes further Capex reductions less feasible.

Data & Statistics Mentioned

• Atlanta Fed’s GDPNow: Currently running at 8% nominal GDP, 5% real GDP.
• Inflation: Near 2%.
• S&P 500 in June 2023: 4300.
• Contribution to Consumption Growth (last 30-40 years): White-collar professional services (25-45 year olds) accounted for the largest share.

Conclusion

Savita Subramanian presents a nuanced outlook, advocating for a shift in investment strategy towards market broadening, particularly focusing on undervalued sectors like Consumer Staples. She emphasizes the importance of understanding the evolving macroeconomic landscape, including the impact of AI on the labor market and the potential implications of rising interest rates. While acknowledging the continued strength of the tech sector, she suggests that its dominance may wane as the market cycle evolves and Capex becomes a more significant driver of growth. The key takeaway is to position portfolios for a broader market rally, rather than relying solely on the performance of a few large-cap technology companies.