Is the S&P 500 Overvalued?
The defining characteristic of the last bull market was its exceedingly narrow breadth, rivalled only by the markets of the 1920s, the “Nifty Fifty” era of the early 1970s, and the internet bubble at the turn of the century. To demonstrate this concept, we provide the accompanying chart which illustrates that non-S&P 500 listed stocks have reached their lowest relative valuation to the S&P 500 in many decades.
All but the most casual market observer will know that the recent bull market was led by the fabled FAANG stocks, plus Microsoft and a handful of other issues.
The concentration of market leadership became extraordinarily pronounced. As a result, the 6 largest companies in the S&P 500 represented an almost 30% weighting.
Indeed, these mega-cap stocks produced more than 50% of the index return by the S&P 500 in recent years. This group of stocks still represents a very large index weighting, despite their general weakness in 2022, which means that further declines on their part will have a significant impact on index performance. The concentration of capital flows into very large-cap S&P 500 stocks has produced a two-tier stock market. With non-S&P 500 currently trading at their most attractive relative valuations in decades.
We hasten to add that attractive relative valuation does not necessarily equate to attractive absolute valuation.
The current very richly priced S&P 500 means that relatively cheap may still not constitute a true bargain. The notable weakness of the FAANGs et al over the last 6-9 months confirmed the current bear market. The end of bull markets has historically begun with price weakness by the previous bull market leaders. Which ultimately resolves into the more general weakness of a bear market.
Ultimately a new crop of market leaders will emerge to lead the next bull market. These future market darlings that will present the greatest opportunities in the next bull market may well be found in the non-S&P 500 stocks. Ones investors currently shun. The end of the current bear market and the beginning of the next bear market remains uncertain given the ample number of catalysts for volatility available.
We continue to believe that volatility will be the defining characteristic of the investment climate of the 2020s.
Therefore, the risks that produce this volatility will make this a difficult decade for investors to navigate. However, we believe that pragmatic investors can do much to control risk. Moreover, take advantage of the great opportunities that will inevitably manifest due to the turbulent markets. If you found this post of interest, you’ll find the Global Investment Letter of value.
Written by Jonathan Baird, CFA
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Is the S&P 500 Overvalued?