No Market Misgiving on This Thanksgiving
Wade Slome, CFA, CFP?
President/Founder, Sidoxia Capital Management, LLC; Author
We’ll see if there is any gravy left for investors during the last month of the year, but so far 2024 has been a satiating feast that has stuffed investors.?There has been a cornucopia of items to be thankful for, including the Federal Reserve, which is expected to provide some dessert this month in the form of its third interest rate cut this year.?
Investors certainly can also be grateful for the performance of the stock market, which has had a phenomenal year thus far (see chart below):
??S&P 500:?+26.5%
??Dow Jones Industrial Average:+19.2%
??NASDAQ:?+28.0%
On a two-year basis, the S&P 500 results look even tastier:?+57.1%
Why is there such a large appetite for stocks? For starters, we are coming off a fresh election last month, and the majority of Americans decided to vote for the new administration that has promised additional stimulative tax cuts, and deregulation. If these promises come to fruition, these changes could augur well for corporate profits and a rising stock market. Regardless of whether your candidate won or lost the election, investors can agree there is less uncertainty with an uncontested election, which is welcomed by all. In addition, the two Fed rate cuts that started in September have also buoyed enthusiasm.?
What is less clear are the effects of President-elect Donald Trump’s tariff policy threats, which if enacted run the risk of increasing inflation, stifling global trade, and jeopardizing future Fed rate cuts. Combined, these negative side effects have the potential of significantly dampening economic growth. On the other hand, if the tariffs are only used as a negotiating tool with our larger trading partners (including China, Mexico, Canada, and Europe), the tariff discussion will likely have more bark than bite. Time will tell.
Dissecting Stock Performance & Valuations
A lot of pundits are pointing to an overheated market, but on a 3-year basis, returns are looking more normalized (+8.2% per year) because of the -20% hit on stocks during 2022. As you may recall, much of the 2022 decline was caused by the Fed slamming on the economic breaks with its fastest rate-hiking cycle in four decades (raising rates from 0.0% to 5.5%).
Objectively, stock values, as measured by the Price-Earnings (P/E) ratio of the S&P 500, are at elevated levels – registering in at approximately 22-times next year’s forecasted profits. As you can see from the?chart below, the stock market is priced at levels not seen since 2001 and valuations are roughly double what they were at the lows of the 2008 Financial Crisis.
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Source:?Yardeni.com
A major reason for escalated valuations has been the concentration of performance in the largest seven companies, or the so-called Magnificent 7 stocks, which include, Apple, Microsoft, Alphabet, Amazon.com, Nvidia, Meta Platforms and Tesla. In fact, the index concentration is the highest it has been in more than a half century – even higher than at the peak of the 2000 Tech Bubble when Cisco Systems, Microsoft, GE, Intel, and Exxon Mobil were the five largest companies by market capitalization (see chart below).
The good news is the other 493 companies in the S&P 500 (I call them the “Absentee 493”) are priced much more reasonably. This bifurcated dynamic between the largest seven companies versus everything else, highlights the plethora of opportunities available to be harvested in Value stocks, Small-cap stocks, and Mid-cap stocks.
As is evident in the?chart below, the S&P 500 index (red-line), which is skewed by the Magnificent 7, is about 30% more expensive than Small-cap and Mid-cap stocks, which are hovering near historically attractive valuation levels.
Source:?Yardeni.com
Value stocks (blue-line) in the market look equally attractive (about 30% cheaper than the S&P 500), as can be seen in the?chart below.
As always, the future is uncertain, and risks abound for next year. But 2024 has been a blockbuster year and there has been plenty to be thankful for, especially the performance of the U.S. stock market.
Wade W. Slome, CFA, CFP?
Plan. Invest. Prosper.