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Don't Bank on Strong Profit Growth to Sustain the Stock Rally

Counting on widespread global growth and double-digit profit gains juiced by tax cuts to propel U.S. stocks higher this year?

Then Bank of America Merrill Lynch has some cautionary words for you: Don’t bank on it -- but try to keep a sunny disposition. In the short term, that might end up being more important for your P&L.

"Based on the past 90 years, the S&P 500 is actually slightly more likely to have a down year when EPS grows by over 10 percent than when it grows by less than 10 percent," write a team led by senior equity and quantitative strategist Dan Suzuki. "In fact, of the 29 down years for the S&P 500, EPS growth was positive almost 70 percent of the time and up double-digits close to 50 percent of the time."

The bank is forecasting profit growth of 16 percent this year for the S&P 500, but wonders if the realization of those earnings estimates will further power the rally, or whether it’s already priced in. According to the team, the correlation between annual earnings growth and the benchmark stock gauge’s coincident one-year return suggests less than 20 percent is attributable to the aggregate bottom line performance.

So what does matter?

"Sentiment plays a larger role, especially in late-stage bull markets," the strategists conclude.

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