BofA Merrill Lynch lifts S&P 500 year-end target to 2,450 from 2,300

Bank of America Merrill Lynch has bumped up its 2017 year-end target for the S&P 500 to reflect the increasing likelihood that we are entering the typical later stages of a bull market, during which fundamentals typically take a back seat to sentiment and technicals.

The bank lifted its target to 2,450 from 2,300, saying the market still has the potential to push higher as investors capitulate into equities. It added that the "great rotation" out of fixed income into equities has yet to happen.

Merrill argued that usually, in the later stages of a bull market, corporate earnings are cyclically elevated and the multiple that the market assigns to those earnings is often elevated.

As a result, market prices can become significantly overvalued relative to their intrinsic fair value, and this divergence can last for years.

"Thus, we would highlight the distinction between our year-end target of 2,450 (driven largely by sentiment and technicals) and our estimated intrinsic fair value of 2,230. For investors with long time horizons, our long-term (year 2025) target of 3,500, which is based solely on valuation, indicates a solid but below-average annual price return of 4-5% (or total return of 6-7%)."

BofA said a combination of improving investor sentiment, accelerating global growth and hopes for stimulus, is propelling the market to new highs and compressing the equity risk premium faster than it had expected.

The bank said the rally in lower quality stocks is likely to fade as we get more details on Trump's potential stimulus and tax reform, where expectations are quite optimistic relative to the likelihood of delays, friction and more negative offsets than the market is currently pricing in.

"Meanwhile, economic surprises are close to a five-year high and we expect S&P 500 earnings growth to decelerate in the second quarter. While we see further room for market sentiment to improve, the market may take some time to digest the recent surge in optimism before heading higher."

So while Merrill reckons stocks will end the year on a firmer footing than they are on currently, it said the road could get bumpy as we head into the spring and summer months.

"As such, we see an elevated probability that the market falls below our 2,230 fair value estimate before the end of the year."