- An ideal setup for the stock market has arrived as earnings grow and the economy slows, Bank of America says.
- The bank said this rare setup—seen just 11% of the time—delivers outsized gains for stocks.
- "The divergence is mainly coming from improving manufacturing vs. slowing services," BofA said.
The stock market has entered an ideal environment to generate further gains as economic growth slows while corporate profits continue to rise, Bank of America said this week.
Bank of America analysts highlighted in a Tuesday note that this ultra-rare scenario, which has happened just 11% of the time since 1950, tends to deliver outsized gains for the stock market.
When earnings per share grow, and GDP growth decelerates, the S&P 500 has historically delivered average quarterly returns of 3.6% with a win ratio of 79%.
Those average returns fall to 3% with a 63% win ratio when earnings growth is falling and the economy is growing and drop to 2% with a 62% win ratio when both earnings and economic growth are falling. And when both the economy and corporate profits are rising, the S&P 500 delivered an average quarterly return of 2% with a 69% win ratio.
The bank said evidence continues to mount that GDP growth will be revised down, as activity moderates and the labor market slows. At the same time, the bank sees corporate profits accelerating, with earnings per share growing 3% over the last 12 months.
"Historically, a slowing GDP + accelerating EPS backdrop has been the best macro environment for stocks. The divergence is mainly coming from improving manufacturing vs. slowing services," Bank of America said. "With a manufacturing recovery underway, improving fundamentals should continue to support the market."
The bank added that companies have plenty of operating leverage to take advantage of, which should mean higher gross margins and, therefore, higher corporate profits even if economic growth continues to moderate.