Chad D. from Orlando, FL asks: Hi Mitch, as we enter into this new year for stocks, the starting point looks like a high one. I see that the forward P/E ratio on the S&P 500 is almost 20 with the December rally, which leads me to believe there’s not much room for upside from here. Unless the stock market gets way overvalued, which also seems negative. You seem to still be bullish, so what’s your take on this?
Mitch’s Response:
Thanks for your email, Chad. That’s a keen observation on your part. As of December 31, 2023, the forward P/E on the S&P 500 was 19.51x, which is considerably higher than the 30-year average of 16.59x. By this measure, it’s fair to say the S&P 500 is fully valued, if not priced a little richly.
If we parse out the S&P 500’s +26.3% return in 2023, we find that multiple expansions accounted for +1791 basis points of the increase. That’s quite a bit, but it also makes sense given the string of negative earnings growth we saw mid-year. Pulling back the curtain a bit more, I’d critically note that a significant amount of 2023 performance attribution came from the “Magnificent Seven” stocks: Apple, Google, Microsoft, Amazon.com, Meta Platforms, Tesla, and Nvidia. Through October 31, the Magnificent Seven accounted for 130% of the S&P 500’s overall returns. Note to readers: I do not make specific security recommendations in this letter.1
7 Secrets to Building the Ultimate Retirement Portfolio!
Navigating through uncertain times is difficult, but I still believe it is possible to achieve your goals. However, achieving these goals involves some work: Defining your investing objectives, determining your asset allocation, and managing investments over time. Our free guide, 7 Secrets to Building the Ultimate DIY Retirement Portfolio2, will help you do just that.
You will get insight on:
• How to accurately establish your retirement income needs
• The two phases of determining your asset allocation
• Developing an investment discipline that allows you to get good results over time
• Investing rules to help you avoid self-sabotage
• Plus, our views on key steps to create and maintain the ultimate retirement portfolio
If you have $500,000 or more to invest, get this guide to learn our ideas on building and maintaining a retirement portfolio to potentially achieve your long-term goals.
Get our FREE guide: 7 Secrets to Building the Ultimate DIY Retirement Portfolio2
It follows that the significant outperformance of the “Magnificent Seven” obfuscates the stock market’s actual valuation, in my view. The best way to understand how is by comparing the cap-weighted valuation of the S&P 500 with the forward P/E on the equal-weighted S&P 500, which would mean giving equal weight to the Magnificent Seven and all other 493 stocks. With this analysis, we find that the S&P 500 equal-weighted index finished the year with a forward P/E of 16.1x—a far more ‘reasonable’ valuation from a historical perspective.
If we also consider the expected earnings rebound in 2024, I would argue that there are several areas of the market where an investor can find attractive valuations and earnings growth this year. Additionally, when investors look beyond U.S. mega-caps (which led the charge in 2023), earnings yields look reasonably relative to history, and in many areas, valuations have improved relative to last year. I think this gives investors a wide opportunity set in the new year, particularly given Zacks’ view that positive operating leverage and productivity gains should continue in 2024.
A final point I’d make here is that valuations are useful tools for making investment decisions, but they’re also not reliable indicators for when investors should buy or sell stocks. A much broader analysis is required, which should include earnings, interest rates, inflation and growth expectations, free cash flow, and so on.
In addition, I recommend downloading our free guide, 7 Secrets to Building the Ultimate DIY Retirement Portfolio3, which provides a step-by-step blueprint to potentially help you build a sound retirement portfolio of your own and pursue long-term investing success.
If you have $500,000 or more to invest, get this guide to learn our ideas on the step-by-step process of building and maintaining a retirement portfolio that will potentially help you reach your goals and enjoy a secure retirement.
Disclosure