Why Bank Of America Sees 2018 Stock Returns Near 20%

After posting stellar gains in 2017, the outlook for U.S. stocks remains bright in 2018, according to an indicator used by Bank of America Merrill Lynch. That same barometer correctly forecast the robust market last year, CNBC reports. Given the indicator's latest reading, "total returns over the subsequent 12 months have been positive 93 percent of the time, with median 12-month returns of 19 percent," as CNBC quotes from a BofA Merrill Lynch Global Research report.

Contrarian Method

Called the Sell Side Consensus Indicator, this market barometer was developed by Merrill Lynch in 1985, per CNBC. It measures the average equity allocation being recommended by market strategists. It's a contrarian indicator based on this specific finding: the more cautious or bearish strategists are, shown by recommending low stock allocations to their clients, the more likely stocks are to post gains in the succeeding 12 months. The reverse also holds: when the strategists are bullish, stocks do less well. Based on data as of November 30, this indicator is registering relatively bearish sentiment, per CNBC.

In 2017, the S&P 500 Index (SPX) rose 19.4% and delivered a total return, including dividends, of 21.8%, according to Yahoo Finance. As of the end of August 2016, the Sell Side indicator was pointing to 12-month total returns of roughly this magnitude over the next 12 months, per that earlier CNBC report. The actual total return on the S&P 500 for the 12 months from September 2016 through August 2017 was 16.2%, per Yahoo Finance.

Bears Vs. BofA 

It would be highly unusual for the stock market to post a 19% total return this year after posting other-worldly returns last year, when stock indexes broke one record after another. As a result, there are many skeptics who argue the stock market will stage a sharp correction, a fall of at least 10 percent, or even slip into a bear market.

One of them is veteran market strategist Byron Wien, currently vice chair of the Private Wealth Solutions Group at The Blackstone Group LLC, who expects a long-overdue market correction to take place in 2018, according to another CNBC report. He foresees a speculative binge in 2018 followed by a selloff that brings the S&P 500 down to 2,300, or 14.7% below its January 3 open, per CNBC. Higher interest rates, spurred by a rollback of quantitative easing by the Federal Reserve, will be a contributing factor in the correction, Wien says. He also anticipates a regulatory crackdown on bitcoin trading, given risks that "are so great," as CNBC quotes him.

'The Market Has Lost Steam'

Upward price momentum in U.S. stocks appears to be weakening, suggesting that a correction may be on the horizon, according to technical analysis by Barron's columnist Michael Kahn. In writing about his analysis of Bollinger Bands for the Dow Jones Industrial Average (DJIA), Kahn says "when the market makes a high above the bands--which we saw in early December--and then makes a higher high within the bands, it tells us the market has lost steam."

Kahn also cites several reasons for bearishness on a fundamental level: tax reform is no longer a source of hopeful speculation; North Korea is making new threats; unrest is building in Iran, a major oil producer; and a U.S. government shutdown may be looming. Additionally, to toss in a seasonal pattern, he cites research from Jeff Hirsch, editor of the Stock Trader's Almanac, indicating that January historically is not a particularly strong month in midterm Congressional election years, as is 2018.

It should be noted that even BofA Merrill Lynch is cautious in the company's official market forecast, calling for the S&P 500 to reach 2,800 in 2018, a modest 3.8% increase from its opening value on January 3. So this shows that BofA Merrill Lynch as a whole is much less bullish than its successful sell side indicator.