Fed policy and a healthy consumer outlook are creating a 'goldilocks' environment that points to more upside ahead for stocks, Bank of America says

• The economy is in a "goldilocks" environment that should lead to more upside for stocks, Bank of America said Wednesday.
• A healthy consumer, accommodative policy from the Fed and Congress, and credit markets are all "just right," BofA said.
• "Given such favorable macro and policy conditions, market history on our side, and more neutral investor positioning, we still favor US equities."
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US stocks should see more upside in the second half of the year as the economy enters a "goldilocks" environment, Bank of America said in a note on Wednesday.

The bank noted that while inflation fears were "too hot" in the second quarter on too much stimulus and a fast economic reopening, growth expectations are now "too cool" as investors fear earnings growth will peak this year.

But consumers, credit markets, and policy from the Fed and Congress represent a "just right" scenario that will help boost US stocks going forward.

"Consumers are just right."

Consumers are sitting on $2.5 trillion in excess cash that is slowly being spent on goods, services, and stocks, according to BofA estimates.

"Instead of splurging on everything at once after the economy reopened, our economists cite a shift from goods to services, with potential for deflation in goods prices next year," BofA explained, noting that today's savings rate of 12.4% is at a 40-year record high.

The bank expects consumers to power a long period of sustained higher spending, rather than a "sugar high" and subsequent crash of consumer spending.

"Credit is just right."

With massive bank balance sheets being parked at the Fed instead of being lent out, there is room for future growth as those balances begin to make their way into the financial system.

"All that dry powder means the financial system is primed for productivity. As employment stabilizes, the capex cycle will accelerate, and lending should pick up shortly thereafter," BofA explained.

More lending will initially support the financial sector, but increased capex from technology companies should help raise productivity and could pressure wages, according to the note.

"More broad-based, higher-quality, and tech-driven lending to raise productivity pushes us toward quality, EPS growth, and banks, with less desire to chase the reflation trades," BofA said.

"Congress & Central banks are just right."

A trillion dollar infrastructure bill should reduce fears of excessive stimulus and reduce the need for punitive tax policies. And while the US Fed has signalled no raise in interest rates until 2023, "markets may not start pricing in those changes until deep into 2022," BofA explained.

Finally, a strong start for stocks in the first half of the year often precedes another strong year ahead. The S&P 500 posted its best start to the year in 23 years, according to BofA.

"Years that begin this well tend to end well, too," BofA said. Since 1871, the 16 years that saw a similar start as 2021 see an average second half return of 8%, with more upside potential than downside risk, the bank said.

"Given such favorable macro and policy conditions, market history on our side, and more neutral investor positioning, we still favor US equities vs. the rest of the world," BofA concluded, adding that any correction in the stock market should be viewed as an opportunity to buy high-quality stocks with strong earnings growth.