Why Bank of America Thinks the S&P 500 Rally Is Running Out of Steam

TLDR

• Bank of America warns the S&P 500 appears overpriced on 18 of 20 valuation metrics, setting a cautious year-end 2026 target of 7,100
• The firm recommends rotating out of expensive tech stocks into health care and real estate sectors, which show improving fundamentals and lower valuations
• Health care posted 10.3% sales growth in Q3 2025 while real estate showed 6.5% sales growth, both outperforming on earnings surprises
• AI adoption could reduce demand for professional service jobs, potentially hurting consumer spending and the economy
• Passive funds now control the majority of S&P 500 float, creating potential liquidity risks if private market stress forces selling

The S&P 500 closed 2025 with a 16% gain, but Bank of America thinks the party might be ending. The investment bank released a strategy note warning that the index looks expensive on nearly every measure and set a year-end 2026 target of 7,100. This represents the most cautious forecast among major Wall Street banks.

Chief equity strategist Savita Subramanian said the S&P 500 appears overpriced on 18 of 20 valuation metrics the firm tracks. These include market cap-to-GDP, price-to-book, and enterprise value-to-sales ratios. Nine of these measures now exceed levels seen at the peak of the dot-com bubble in March 2000.

The bank’s concerns center on what happens when markets price in perfection. Growth must stay high, margins must hold steady, and earnings surprises must break favorably. When valuations reach these levels, the market stops forgiving mistakes.

The index’s three-month return stood at 6.02% as of November 2025, down from 7.90% the prior month. This slowdown in momentum comes as the tech sector’s dominance faces questions. The “Magnificent 7” tech stocks contributed 54% of the S&P 500’s price gain and 44.1% of earnings growth through Q3 2025.

Subramanian argues that today’s index differs from past cycles. The S&P 500 now consists of higher-quality, asset-light businesses with strong balance sheets and healthy margins. These companies deserve premium valuations but create risk when priced for perfection.

Health Care and Real Estate Show Better Value

Bank of America assigned overweight ratings to health care and real estate for a nearly one-year time frame. The firm’s momentum and value model ranks health care as the most attractive sector and real estate third. The appeal comes from both lower valuations and improving fundamentals.

Health care posted 10.3% year-over-year sales growth in Q3 2025, one of the strongest rates among S&P 500 sectors. The sector’s sales jumped 8% at quarter-end as companies delivered positive surprises. Earnings growth rose to 5.2% from 1.4%, with the sector posting a 12.1% aggregate earnings surprise.

Real estate showed approximately 2.5% year-over-year growth in earnings per share alongside nearly 6.5% sales growth. Despite these strong performances, the sectors lagged tech in 2025 returns. The Health Care Select Sector SPDR Fund returned 13% while the Technology Select Sector SPDR Fund gained 24%. Real estate posted just a 0.3% gain.

This performance gap could fuel rotation out of tech stocks. Subramanian argues investors should hunt for selective opportunities rather than own the index outright. The firm maintains market weight on technology despite it ranking second in their model.

AI Threatens Professional Service Jobs

Subramanian highlighted tension between AI growth and consumer spending. Professional and business services workers have driven the most consumption growth since the 1980s. These workers now face pressure as companies use AI to automate white-collar tasks.

The November 2025 jobs report from the Bureau of Labor Statistics showed “little change” in employment for the professional and business services sector. Amazon CEO Andy Jassy warned that companies will need fewer people doing some current jobs and more people doing other types of work.

Recent hiring trends suggest demand for professional roles will slow before new AI-related jobs appear. If this gap persists, consumer spending will likely decline. Bank of America remains underweight on consumer discretionary and communication services, citing greater risk than reward.

The firm also warned about structural risks from asset allocation trends. Many pensions and asset owners now pair passive S&P 500 index exposure with private equity and private credit holdings. Passive funds account for the majority of the S&P 500’s float.

If stress in private lending continues or interest rates don’t return to lower levels, some asset owners could be forced to sell liquid equity holdings. This could happen gradually or through sharp bouts of forced selling. Bank of America described consumer staples as a potential “value trap” despite maintaining an overweight strategic position on the sector.

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