How to Invest As Inflation Rises to a 40-Year High: Bank of America - Business Insider

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Stocks are off to a choppy start in 2022, to say the least. The S&P 500 is down 7% and the tech-focused Nasdaq is in correction territory as inflation concerns begin to turn into panic.
Investors are unsure whether the bottom is in or if there’s more pain ahead. Bank of America’s answer? There’s more seesawing yet to come, so choose investment opportunities carefully.
“We are not outright bearish given still healthy fundamentals, but we expect the market to remain volatile throughout the year, with so far no signs of inflation easing,” wrote Savita Subramanian, BofA’s head of US equity and quantitative strategy, in a February 11 note.
Both bulls and bears could make their case based on recent market moves. According to Subramanian’s note, although some froth was removed from the historically expensive market after the sharp declines in January, the S&P 500’s forward price-to-earnings (P/E) ratio of 20x still eclipses the 14x to 18x range from 2015 to 2019 and its long-term average of 15.6x. 
Bank of America is neutral on US stocks. The firm’s 2022 S&P 500 target of 4,600, which is the second-lowest among its Wall Street peers, represents just 3% upside from current levels.
But that doesn’t mean investors should simply go into cash. Inflation running at 40-year highs means that money sitting idle in a savings account is losing its value. And bond yields, though rising, are still relatively low; the 10-year US Treasury Note currently yields 2%.
In this challenging environment, Bank of America believes the key to outperformance is owning stocks in the right sectors and industries. Growth stocks will lag this year because of pricy valuations and lackluster earnings, but the wrong types of value stocks will underwhelm as well, Subramanian wrote, noting that “not all value stocks are created equal.”
So-called “value traps” are among the worst types of stocks to own. These companies look cheap based on traditional valuation metrics, but declining earnings mean they’re “inexpensive for wrong reasons,” Subramanian said. These stocks have trailed the most expensive 10% of S&P 500 stocks by 4% per year since 1997, according to Bank of America data.
Current examples of sectors and industries that are “value traps,” in Bank of America’s view, include Interactive Media & Services — home to high-profile growth stocks like Alphabet and Meta Platforms — and Independent Utilities.
However, there are opportunities to be found within select industries in the Healthcare, Materials, Semiconductor, and Energy sectors, according to BofA. It should be noted that Energy was the firm’s top tactical sector for the eighth month in a row and for 12 of the past 13 months.
Energy stocks have been on fire in 2022 and are up about 26% year-to-date, but BofA data indicates that there may be more room to run for this standout group. Common stock valuation metrics, including price-to-book, price-to-operating-cash-flow, and forward P/E ratios, imply that the sector still has between 61% and 71% upside, according to Bank of America.
Bank of America ranked 60 different industries on a scale of 1-10, with 10 being the best score, on their price momentum, earnings momentum, and valuation. All nine industries listed below scored an above-average rank in those three categories.
Within these industries, Bank of America is looking for “value stocks with strong free cash flow, inflation protection, and improving fundamentals.” Although Bank of America didn’t provide any specific investment recommendations, along with each industry’s rankings is an example of an exchange-traded fund (ETF) investors could use to play the trend.
Sector: Healthcare
Price momentum rank: 9
Earnings momentum rank: 10
Valuation rank: 10
Industry ETF: iShares U.S. Pharmaceuticals ETF (IHE)
Source: Bank of America
Sector: Energy
Price momentum rank: 10
Earnings momentum rank: 10
Valuation rank: 9
Industry ETF: SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
Source: Bank of America
Sector: Healthcare
Price momentum rank: 10
Earnings momentum rank: 8
Valuation rank: 9
Industry ETF: iShares US Medical Devices ETF (IHI)
Source: Bank of America
Sector: Energy
Price momentum rank: 10
Earnings momentum rank: 9
Valuation rank: 8
Industry ETF: iShares U.S. Oil Equipment & Services ETF (IEZ)
Source: Bank of America
Sector: Materials
Price momentum rank: 7
Earnings momentum rank: 9
Valuation rank: 9
Industry ETF: iShares U.S. Home Construction ETF (ITB)
Source: Bank of America
Sector: Consumer Discretionary
Price momentum rank: 6
Earnings momentum rank: 9
Valuation rank: 7
Industry ETF: Consumer Discretionary Select Sector SPDR Fund (XLY)
Source: Bank of America
Sector: Consumer Discretionary
Price momentum rank: 6
Earnings momentum rank: 8
Valuation rank: 7
Industry ETF: SPDR S&P Retail ETF (XRT)
Source: Bank of America
Sector: Materials
Price momentum rank: 6
Earnings momentum rank: 9
Valuation rank: 6
Industry ETF: Vanguard Materials ETF (VAW)
Source: Bank of America
Sector: Information Technology
Price momentum rank: 8
Earnings momentum rank: 6
Valuation rank: 6
Industry ETF: VanEck Semiconductor ETF (SMH)
Source: Bank of America
Get the latest Bank of America stock price here.
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