Investing.com -- The S&P 500 is currently considered statistically expensive across 19 of 20 valuation metrics, indicating limited long-term price growth, Bank of America said in a Monday report.
BofA's analysis of the index, particularly using Price to Normalized Earnings – the bank’s best predictor of 10-year returns – suggests an annualized price return of just 1-2% over the next decade
The equal-weighted version of the index, however, offers a more attractive 4-5% price return, indicating the potential for higher returns outside of the largest S&P 500 names.
“This is not new news: we have seen a more compelling valuation case for the equal-weighted S&P 500 since last July which now trades at a historic discount to the cap-weighted index,” BofA strategists led by Savita Subramanian said in the note.
“Here, valuation indicates 4-5ppt returns over for the average stock over the next decade.”
But, this is only one part of the story, BofA notes, highlighting that dividends remain an important part of total returns.
While dividends accounted for a meager 16% of total returns in the past decade, they historically contributed 40%. Should dividends revert to their historic levels, the S&P 500’s total return could rise significantly, particularly if investors reinvest them.
“If dividends reverted to their average contribution, assuming reinvestment, the equal-weighted S&P 500’s total return would clear 8.3% p.a. over the next decade," the note points out.
BofA notes that two companies from the "Magnificent 7" recently initiated dividends, signaling the potential for further dividend growth "that would offset low price return."
Another important consideration is the shift in the corporate landscape. Today's market is more asset-light, labor-light, and debt-light compared to past cycles. BofA highlights that this shift could justify higher valuation multiples than history suggests, possibly explaining part of the current premium.
Still, BofA retains a cautious stance, stressing that price returns alone will remain modest unless inflation plummets. Total returns, when adjusted for inflation, are still expected to surpass the real yields of 10-year Treasury bonds under current conditions.