Stock markets are increasingly scrutinizing value-based pricing issues, highlighting the potential perils associated with this approach.
The S&P 500 is currently experiencing a rally, setting records, but a closer look at the stock market today reveals a mixed picture when it comes to earnings and valuations. The materials sector, which consists mainly of chemical and mining companies, has seen a 9% rise this year, yet earnings have fallen by 13%. This discrepancy highlights the uneven performance across different sectors. Jim Paulsen, an investment strategist, suggests that the earnings success during the bull run was largely confined to information sector companies. An index of S&P 500 companies excluding technology has risen by 13% over the past year, but earnings have grown by only 6.4%. Concerns about a stock market bubble have been growing due to the overheated valuation of the S&P 500. The index is currently trading at 27 times expected earnings, with the Shiller P/E at around 40 and the Buffett Indicator at a record level of 217%. The technology sector, however, has had an outsized influence on this year's gains in the S&P 500. Five megacap tech companies account for half of its 12% rise. Tech giants like Nvidia, Microsoft, Meta Platforms, Alphabet, etc., have risen by around 15% this year, essentially in line with the 16% growth in earnings per share. A closer look reveals that these tech giants have largely justified their high valuations with earnings growth that supports their stock price increases. The "Magnificent Seven", which include some of the tech giants, have a P/E ratio of 43, higher than the broader market. However, a 20% earnings growth forecast for the next 12 months could partially justify their prices. Interestingly, the S&P 500 Information Technology Index has risen by 27%, a rate that seems more in line with the sector's 26.9% earnings growth. Paulsen suggests that it's tempting to say that these companies don't deserve their current high valuations, but they have grown strongly during the bull run. However, it's worth noting that Dow Inc., currently the most expensive stock in the entire S&P 500, is trading at 914 times earnings. Outside the technology sector, some of the most expensive S&P 500 stocks receiving special focus are leading consumer goods and luxury companies such as LVMH, Hermès, L'Oréal, McDonald's, and Starbucks, valued for their quality, trust, and loyalty. Ed Clissold, Chief U.S. Strategist at Ned Davis Research, points out that the S&P 500 has risen 83% from the bear market low in 2022, while earnings have only increased by 16% in the same period. Clissold notes that excessive valuations are not limited to the technology sector, even when excluding outliers (mega-cap stocks), both the average stocks and the cheapest stocks are expensive. Some non-tech companies like Oracle and Broadcom are trading at high valuations, with Oracle trading at 67 times its earnings and Broadcom at 86 times. The "Magnificent Seven" have seen their P/E ratios fall by 7.9% despite stocks rising by 18%. In conclusion, while the S&P 500 is currently experiencing a rally, there are concerns about overheated valuations, particularly in the technology sector. However, it's important to note that some non-tech companies are also trading at high valuations, and the market's performance varies across different sectors.
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