BofA thinks S&P 500 may drop another 23% in worst-case scenario

• The S&P 500 may fall below 3,000 in the worst-case scenario, according to Bank of America.
• The index closed on Friday at approximately 3,912, and BofA’s prediction represents a 23 percent additional decline.
• BofA also projected that the stock market has already priced in a one-third likelihood of a recession.

S&P 500 is settling into a bear market that could drive the index as low as 3,000, according to a note published by Bank of America on Friday.

The broad index completed the week at approximately 3,912, so BofA’s projection suggests a 23 percent possible loss.

In the meantime, the stock market has already priced in a one-third likelihood of a recession, according to the report, which also stated that using the price-to-earnings ratio to predict the performance of the S&P 500 is less trustworthy than using the equity risk premium.

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Analysts noted that the current bear market is the 27th since 1929, and historically, bear markets have resulted in an average fall of 35 percent. This means that the S&P 500 would bottom near 3,100, which is essentially consistent with BofA’s worst-case scenario of approximately 3,000 based on its equity risk premium framework.

In recent weeks, the likelihood of a recession has increased as analysts assert the Federal Reserve was too slow to combat inflation and must now rapidly tighten monetary policy, threatening to end the economic recovery.

However, this does not imply that investors remain inactive. Noting that energy has outperformed the S&P 500 by 44 percentage points, BofA advised remaining long on the energy sector while avoiding consumer discretionary sectors.

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Brent crude remains above $100 a barrel, and a rise in fresh supply is unlikely to exert significant downward pressure. BofA estimates that US oil companies’ capital expenditures as a proportion of operating cash flow have reached a historic low of 30%, down from a range of 80% to 100% between 2011 and 2016.

“On the flip side, Consumer Discretionary ranks at the bottom,” analysts wrote. “As evidenced by retailers’ recent earnings, consumers’ shift from discretionary items to necessities poses a further risk. Moreover, Energy and Consumer Discretionary earnings have historically been negatively correlated.”