Bank of America: Bullish on US stocks, but don't buy the S&P 500!

Economists are increasingly predicting that the US economy can avoid a recession. This should give a boost to the US stock market before the end of the year, but US banks suggest that investors should adopt an equal-weighted approach to the S&P 500 index for maximum returns.

Favoring the Equal-Weighted S&P 500 Index

Bank of America stock and quantitative strategist Savita Subramanian has raised the year-end target for the S&P 500 index from 4300 points to 4600 points, indicating a potential 4% upside for the index.

Her optimism for the S&P 500 index exceeds the general expectations on Wall Street. The strategist says that when Wall Street strategists unanimously predict a decline in US stocks, the market actually ends up rising 100% of the time.

The S&P 500 index is market-cap weighted, so for example, Apple with a market cap of $2.8 trillion has a weight of 7%.

However, Subramanian suggests that investors are better off adopting an equal-weighted approach to investing in the index.

It is worth mentioning that the Invesco S&P 500 Equal Weight ETF (RSP) has risen 5% year-to-date, while the market-cap weighted S&P 500 index ETF has risen 17%.

The valuation gap between the two indices is at its highest level since the dot-com bubble era.

Investment Strategy

Subramanian says that investment trends may also shift towards some so-called "old" economy and more cyclical companies, which are not fully reflected in mutual funds but are more prevalent in the equal-weighted S&P 500 index.

The strategist also states that the second quarter is a trough for earnings, and the recovery in profits will benefit value stocks, which have a higher representation in the equal-weighted S&P 500 index.

Among all industries, the technology sector has the highest overseas risk exposure, while domestically-oriented "old" economy companies such as manufacturers will benefit from the trend of supply chain diversification.

Another reason for optimism towards industrial and other economically sensitive stocks is the revival of US manufacturing.

Some "old" economy companies can also reap as many benefits as technology companies from productivity improvements brought about by automation and artificial intelligence. However, she adds that the valuations of these companies have not reflected these potential improvements as much as those of more technology-oriented companies.