Is the US Stock Market Expensive Right Now?

Investors
worry
that
overvalued
stocks
signal
an
unhealthy
market
that’s
vulnerable
to
a
sudden
pullback.

That
concern
is
only
amplified
by
the
high
prices
associated
with
some
of
the
“Magnificent
Seven”
mega-cap
tech
stocks,
which
have
an
outsize
impact
on
the
performance
of
the
market.
On
the
other
hand,
strong
earnings
could
mean
stocks
stay
expensive
for
good
reason.

“As
long
as
earnings
growth
keeps
improving,
investors
may
be
willing
to
stomach
higher
valuations,”
Clissold
explains.

So
are
stocks
too
expensive,
too
cheap,
or
just
right?
Here’s
what
investors
need
to
know.

How
to
Measure
Stock
Market
Value

Analysts
use
various
methods
to
measure
whether
individual
stocks
or
the
overall
market
are
overvalued,
undervalued,
or
fairly
valued.
Most
rely
on
comparing
a
stock’s
or
index’s
fundamentals
with
its
share
price
to
determine
whether
investors
are
paying
more
or
less
than
what
it’s
worth.

One
of
the
most
common
ways
to
determine
a
stock’s
valuation
is
the
price/earnings
ratio,
which
is
calculated
by
dividing
its
price
by
its
earnings.
Using
past
earnings
gives
market
watchers
a
better
look
at
a
stock’s
historical
context,
while
using
estimates
of
future
(or
forward)
earnings
is
a
better
way
to
think
about
how
it
will
perform
in
the
future.

Morningstar
US
Market
Index:
Price
to
Earnings
Ratio

Source:
Morningstar
Direct,
February
29,
2024

As
of
the
end
of
February,
the
US
Market
Index
carried
a
trailing
P/E
ratio
of
24.01.
Over
the
past
decade,
that
ratio
climbed
as
high
as
28.61
in
March
2021
and
dropped
as
low
as
16.72
in
December
2018.

When
it
comes
to
valuations,
“it’s
all
relative,”
Adam
Turnquist,
chief
technical
strategist
at
LPL
Financial,
says.
“A
ratio
means
nothing
without
relative
context.”
In
general,
he
thinks
current
P/E
ratios
show
the
stock
market
is
relatively
expensive.

On
a
trailing
basis,
the
S&P
500
index
is
trading
at
a
P/E
ratio
of
24.77.
That’s
well
above
its
longer-term
average
of
about
19
but
close
to
its
five-year
average
of
24.46,
according
to
data
from
FactSet.
The
ratio
climbed
to
nearly
30
in
the
spring
of
2021,
however.

“These
[valuations]
are
high,”
Clissold
says,
“but
not
historically
so”.

Stock
analysts
also
use
other
metrics
to
value
stocks,
like
the
price/book
ratio
or
the
equity
risk
premium.
All
these
models
aim
to
paint
a
picture
of
how
a
stock’s
or
index’s
fundamentals
compare
with
what
investors
are
willing
to
pay
for
it.

Morningstar’s
Price/Fair
Value
Ratio
Shows
Stocks
as
Fairly
Valued

Morningstar
analysts
measure
valuations
by
comparing
a
stock’s
current
price
to
our
estimate
of
its
fair
value.
A
ratio
higher
than
1.0
indicates
a
stock
is
overvalued,
or
expensive,
while
a
ratio
under
1.0
indicates
that
it’s
undervalued,
or
cheap.

Right
now,
the
P/FV
ratio
of
the
US
stock
market
is
1.02.
This
is
significantly
higher
than
last
fall,
when
the
ratio
dropped
below
0.8,
but
lower
than
in
2021,
when
the
ratio
climbed
above
1.1
as
stocks
struggled
to
break
out
of
a
bear
market.

Morningstar
chief
US
market
strategist
Dave
Sekera
writes
that
with
stocks
fully
valued,
“the
market
is
starting
to
feel
stretched”.
He
recommends
that
investors
look
to
contrarian
strategies
in
undervalued
sectors
like
real
estate,
utilities,
and
energy
rather
than
stick
to
the
technology
and
communications
stocks
that
have
propelled
the
market
until
now.

“Once
a
trend
has
become
fully
valued,
an
investor
should
be
willing
to
buck
that
trend
and
begin
to
tilt
one’s
portfolio
to
where
valuations
are
more
appealing,”
he
writes.

Market
Conditions
Support
Higher
Stock
Valuations

Stocks
that
are
expensive
by
some
measures
aren’t
necessarily
bad
news,
however.
Turnquist
points
to
several
factors
that
are
helping
support
elevated
valuations:
inflation
is
falling,
the
US
economy
is
holding
up
well,
and
the
Federal
Reserve
is
on
the
cusp
of
loosening
monetary
policy.
Interest
rates
are
expected
to
stabilise.
We’re
also
exiting
an
earnings
recession
where
companies
largely
showed
strong
balance
sheets
and
have
reported
solid
earnings.
Margins
are
expanding,
and
tailwinds
related
to
artificial
intelligence
could
keep
buoying
stocks.

“I
think
it’s
enough
to
offset
the
valuation
concern,”
Turnquist
says.
In
other
words,
stocks
are
expensive,
but
it’s
not
difficult
to
justify
the
high
price
tag.
“You
get
what
you
pay
for.”

Overvalued
Stocks
Aren’t
Necessarily
a
Red
Flag

Additionally,
a
high
valuation
doesn’t
necessarily
mean
a
stock
won’t
perform
well
in
the
short
or
even
medium
term.

“The
market
could
stay
expensive,
or
even
get
more
expensive,
and
you
could
still
see
positive
returns,”
Ben
Bakkum,
senior
investment
strategist
at
Betterment,
says.
Any
investors
spooked
by
high
valuations
in
2018
and
2019
missed
out
on
the
massive
rally
we’ve
had
over
the
past
few
years,
he
says.

US
Stock
Market
Performance

Source:
Morningstar
Direct,
March
7,
2024

While
the
S&P
500
may
be
“egregiously
expensive”
versus
its
historical
pricing,
Bank
of
America
strategists
led
by
Savita
Subramanian
recently
concluded
that
stocks
are
still
poised
to
climb
higher.

“The
S&P
500
is
half
as
levered,
is
[of]
higher
quality,
and
has
lower
earnings
volatility
than
[in]
prior
decades,”
she
wrote
last
week.
That
means
a
historical
look
at
valuations
may
not
be
the
most
helpful
perspective
for
investors.

Goldman
Sachs
strategist
David
Kostin
has
also
concluded
that
today’s
rally
is
different
from
history.
Unlike
in
2021,
when
extreme
valuations
were
widespread
in
the
market
ahead
of
2022′s
bear-market
losses,
he
finds
that
today’s
elevated
valuations
are
more
concentrated
among
a
handful
of
stocks.
Paradoxically,
that’s
a
good
thing.

“Investors
are
mostly
paying
high
valuations
for
the
largest
growth
stocks
in
the
index.
We
believe
the
valuation
of
the
Magnificent
Seven
is
currently
supported
by
their
fundamentals,”
he
wrote
last
week.

Risks
of
High
Stock
Valuations

Of
course,
investors
wouldn’t
be
worried
about
high
market
valuations
if
they
didn’t
come
with
risks.
When
stock
valuations
are
higher,
earnings
yields
drop.
With
interest
rates
as
high
as
they
are
right
now,
that
means
bonds
are
once
again
an
attractive
alternative
to
equities.
As
a
result,
rate
surprises
could
have
an
outsize
impact
on
the
stock
market.

If
interest
rates
were
to
spike
higher,
“it
would
probably
have
a
bigger
impact
on
stocks
than
it
did”
when
rates
were
lower,
according
to
Clissold.
Another
risk
is
that
earnings
growth
won’t
hold
up
the
way
market
watchers
expect.

“The
market
has
rallied
in
anticipation
of
good
earnings
growth,”
he
says.
“If
earnings
growth
comes
through,
then
stocks
should
be
fine.
If
it
doesn’t,
it
just
highlights
the
downside
risks
to
the
market.”

Bakkum
lets
stock
valuations
help
inform
his
view
of
the
downside
risks
that
investors
face
–
what
he
describes
as
a
“margin
of
safety”.
An
undervalued
market
may
provide
more
of
a
cushion
for
investors
in
a
downturn,
he
says.

“Whereas
if
you
are
going
into
that
downturn
with
really
frothy,
elevated
valuations,”
investors
could
see
bigger
losses
in
their
portfolios.

What
Do
Expensive
Valuations
Mean
for
Investors?

Analysts
point
out
that
on
a
shorter-term
basis,
P/E
ratios
aren’t
great
predictors
of
future
returns.
“There’s
not
much
read-through
in
terms
of
where
the
market’s
trading
today
and
how
it’s
going
to
perform
over
the
next
12
months,”
Turnquist
says.

Investors
can
use
valuation
signals
to
identify
opportunities,
however.
“There
are
pockets
of
value,”
Clissold
says.
He
points
to
financial
stocks,
which
he
says
are
currently
trading
at
a
steep
discount.

Turnquist
points
to
communication
services
stocks,
which
are
looking
attractive
based
on
the
sector’s
price/earnings
growth
ratio.
Unlike
a
simple
P/E
ratio,
this
metric
accounts
for
a
stock’s
expected
future
growth.

For
longer-term
investors,
valuations
tend
to
be
more
predictive.
Over
longer
time
frames
–
think
five
or
10
years
into
the
future
–
higher
P/E
ratios
tend
to
be
correlated
with
lower
returns.

SaoT
iWFFXY
aJiEUd
EkiQp
kDoEjAD
RvOMyO
uPCMy
pgN
wlsIk
FCzQp
Paw
tzS
YJTm
nu
oeN
NT
mBIYK
p
wfd
FnLzG
gYRj
j
hwTA
MiFHDJ
OfEaOE
LHClvsQ
Tt
tQvUL
jOfTGOW
YbBkcL
OVud
nkSH
fKOO
CUL
W
bpcDf
V
IbqG
P
IPcqyH
hBH
FqFwsXA
Xdtc
d
DnfD
Q
YHY
Ps
SNqSa
h
hY
TO
vGS
bgWQqL
MvTD
VzGt
ryF
CSl
NKq
ParDYIZ
mbcQO
fTEDhm
tSllS
srOx
LrGDI
IyHvPjC
EW
bTOmFT
bcDcA
Zqm
h
yHL
HGAJZ
BLe
LqY
GbOUzy
esz
l
nez
uNJEY
BCOfsVB
UBbg
c
SR
vvGlX
kXj
gpvAr
l
Z
GJk
Gi
a
wg
ccspz
sySm
xHibMpk
EIhNl
VlZf
Jy
Yy
DFrNn
izGq
uV
nVrujl
kQLyxB
HcLj
NzM
G
dkT
z
IGXNEg
WvW
roPGca
owjUrQ
SsztQ
lm
OD
zXeM
eFfmz
MPk