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US stocks: bubbly, or expensive for a reason?

High valuations are largely concentrated in a small number of ultra-profitable, mega-cap technology stocks, says Goldman Sachs

Stock market valuations once seen as bubbly 'appear to be the new steady state'. Photograph: Charly Triballeau/AFP/Getty Images

Proinsias O'Mahony
Tue Mar 26 2024 - 05:00

The S&P 500 has rallied almost 50 per cent since bottoming 18 months ago and there’s little sign of a slowdown, with the index up 8 per cent already in 2024 and hitting 18 record highs this year.

Are things getting frothy? Bulls don’t deny stocks look expensive, but suggest that may not matter.

Bank of America’s Savita Subramanian recently said the S&P 500 is “egregiously expensive” relative to its past, with 19 of 20 valuation metrics indicating stocks look pricey relative to history. The index trades on 24.5 times trailing earnings, which is more than 95.5 per cent of prior readings. Time to run for the hills? No, says Subramanian, who notes profit margins have nearly doubled from 6 per cent in the 1980s to almost 12 per cent today. The S&P 500 is “half as levered, is higher quality and has lower earnings volatility than prior decades”, so it deserves to be more expensive today.

Similarly, Ritholtz Wealth Management’s Michael Batnick notes the S&P 500′s cyclically-adjusted price-earnings ratio has averaged 26 over the last 20 years. Before the dotcom bubble, such a reading was only ever seen once, during the speculative mania of the roaring 20s, which was followed by the 1929 Wall Street crash.

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Quite simply, markets have changed: valuations once seen as bubbly “appear to be the new steady state”, says Batnick.

High valuations are largely concentrated in a small number of ultra-profitable, mega-cap technology stocks, says Goldman Sachs, and these elevated valuations are largely supported by their fundamentals. In other words, the US may appear expensive, but it’s more expensive for a reason.

Proinsias O'Mahony

Proinsias O'Mahony

Proinsias O’Mahony, a contributor to The Irish Times, writes the weekly Stocktake column

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