BofA Predicts Flat S&P 500 in 2022

Within the U.S. stock market, BofA Securities strategists favor small-caps because of valuations. Smal-caps are now trading at a 23% price/earnings discount to large-caps versus the historical 2% premium, said Jill Carey Hall, head of U.S. SMID-Cap Strategy at BofA Securities. She explained the forward P/E for small-caps is about 8% above the historical average versus a 30% premium for large-caps.

Hall said small-caps have more pricing power than large-caps in a more inflationary environment, and they can continue to gain so long as the COVID backdrop improves.

The trajectory of the pandemic is "the biggest risk factor" for the U.S. economy, said Michelle Meyer, head of U.S. Economics at BofA Securities. "We're not out of the pandemic economy. We still don't know when we'll actually be past it. We're still in a transition phase."

The emergence of the new omicron variant of the coronavirus only reinforces that outlook. The variant has more mutations than any previous variants, but it's not yet known if it is also more transmissible or deadly. The variant is currently spreading in Europe and Africa and is expected to surface in the U.S., though as of Monday evening there was no confirmation of cases in the U.S.

Meyer is expecting the U.S. economy will grow at a 6% rate in 2021, 4% next year and 2% in 2023. The BofA economic outlook assumes no major shock from COVID, said Meyer, but she recommends that investors "be mindful of another wave coming."

Meyer is forecasting three Fed rate hikes in 2022, four in 2023 and possibly one in 2024, which is about one more hike than what many economists have been forecasting in each of the next two years. Meyer expects core inflation will remove above the Fed's 2% target and advises investors to keep a close watch on inflation expectations, which have been rising among businesses and consumers.