The S&P 500’s forward price-to-earnings (P/E) ratio has rebounded from a 29.5% drop in October 2022, reaching 22.3 at the end of November, as investors reassess their views on economic growth and earnings prospects.
Industry analysts initially predicted a decline in operating earnings per share (EPS) for S&P 500 companies by 0.2% and 1.9% for 2022 and 2023, respectively. However, after fears of an imminent recession subsided, the forward P/E ratio increased significantly, driven by growing confidence in the economy’s resilience.
The recent recovery in the forward P/E ratio is attributed to investors’ increasing optimism about the duration of the economic expansion. As the Fed has been cutting interest rates since September 2022, reducing the risk of a recession caused by monetary policy tightening, investors are now focusing on other potential risks, such as geopolitical crises or trade tensions.
Valuation metrics suggest that the S&P 500’s valuation is still stretched, with the trailing P/E ratio rising to 27.1 in Q3-2024, exceeding its historical average. The Buffett Ratio has also reached a record high of 2.96, indicating that many analysts believe the market is overvalued.
Despite this, some investors remain bullish on the market, citing the collective forward P/E of the Magnificent-7 companies as a driver of growth in earnings relative to sales. However, the S&P 500’s median forward P/E remains at 19.8, and the Fed Model’s correlation between forward earnings yield and the 10-year Treasury bond yield is still divergent.
In conclusion, while market valuation metrics suggest that the S&P 500 is still overvalued, investors’ renewed confidence in economic growth has driven a significant rebound in the forward P/E ratio. As the market continues to evolve, it remains essential for investors to monitor valuation metrics and adjust their strategies accordingly.
Source: https://www.investing.com/analysis/does-the-stock-market-have-a-valuation-problem-200655023