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Is The S&P 500 A Bargain Now?

By Mike Zaccardi, CFA, CMTStock MarketsOct 03, 2022 06:01AM ET
www.investing.com/analysis/is-the-sp-500-a-bargain-now-200630577
Is The S&P 500 A Bargain Now?
By Mike Zaccardi, CFA, CMT   |  Oct 03, 2022 06:01AM ET
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  • The S&P 500’s forward operating P/E ratio has fallen back to near 15
  • Higher interest rates imply assets should be priced lower
  • Is a much lower P/E reasonable?

Few topics get finance folks in a frenzy like discussing valuation and what’s a fair P/E multiple on the S&P 500 right now. Go back just a year—the so-called discounted cash flow (DCF) valuation method was laughed at by many new investors as so many non-income-producing assets surged in value. Cryptocurrencies, non-fungible tokens (NFTs), and even many non-profitable story stocks were the hot assets. Interestingly, value equities—those that produce near-term cash flows—actually did just fine then, too.

Arguments for A Much Lower P/E

Bring you back to the present, now the very mention that the stock market is a decent bargain gets met with reply and after reply that:

  • We do not know what the 'E' will be in the price-to-earnings multiple
  • Higher interest rates today make the S&P 500’s 15.1 forward operating P/E not cheap and, if anything, expensive.

So, all of a sudden, discounting cash flows is more important than ever. Who knew!

Studying History

I went looking back into the data to see if I can suss out what is a real argument and what’s just fearmongering. It turns out that today’s 3.8% yield on the U.S. 10-year Treasury note is the exact average since 1994. In just the past 25 years, today’s benchmark rate is slightly higher than the 3.4% average. So, it is reasonable to surmise that a significantly lower P/E is warranted in October 2022 versus October 2021 when the 10-year was 1.5%.

U.S. 10-Year Treasury Rate Since 1994

10-Year Treasuries
10-Year Treasuries

Source: St. Louis Federal Reserve

What’s interesting, though, is that the median S&P 500 company’s P/E ratio is just 14.5, according to J.P. Morgan Asset Management. That compares to a 25-year average of 16.0. This is an important perspective since the SPX is more top-heavy and tech-oriented today versus the average over the last quarter-century. Like any kind of good market analysis, you cannot assume the past looks exactly like the present and future. By this gauge, your average stock appears reasonably priced.

S&P 500 Valuation: The Median Stock’s P/E is the Lowest Since Early 2013

S&P P/E
S&P P/E

Source: J.P. Morgan Asset Management

But just how much has the composition of the S&P 500 changed over time? There’s a chart I like to reference from Goldman Sachs Global Investment Research that shows how things have evolved since 1975.

Through mid-2022, the Technology sector took up a 27% chunk of the total market cap while low-P/E sectors like Energy and Financials comprise just 15% of the index. It used to be that those two now value niches were a much bigger piece of the market. The point here is that higher-multiple growth sectors are a bigger piece of the stock market pie these days, so a higher overall P/E is reasonable.

S&P 500 Sector Composition Since 1975

S&P Sector Composition
S&P Sector Composition

Source: Goldman Sachs Global Investment Research

The Bottom Line

Long-term investors should take some comfort in today’s stock and bond market valuations. A 15 forward operating P/E on the SPX is not a screaming buy, but it is not pricey. Today’s profit ratio is much different from the same valuation, say, in the mid-2000s. Moreover, the median S&P 500 company trades at an even lower earnings multiple versus the market average.

In advance of Halloween, the bears can point to one eerie stat as we head into the notoriously volatile month of October—the S&P 500’s P/E and dividend yield today (15.1 and 1.9%, respectively) are the same as when stocks peaked in October 2007. Boo!

Disclaimer: Mike Zaccardi does not own any of the securities mentioned in this article.

Is The S&P 500 A Bargain Now?
 

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Is The S&P 500 A Bargain Now?

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Comments (15)
Michael Wilson
Michael Wilson Oct 04, 2022 6:58AM ET
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The Buffett Indicator says that stocks are still 20% overvalued, so SPX 3000 is fair value. If the Fed stays on the path it has laid out, we should drop to that point. Why? Because eventually due to high financial leverage something will break. There will be a Black Swan event. We almost had one when pension funds in the UK were days from blowing up. Remember that no one had warned previously about that. Then there is $52B in the Shadow Banking System. What will happen there if the Fed raises to 5%? However, that said, stocks hit the 200 WMA, the BOE pivoted, allowing Wall Street to speculate that the Fed will follow, investor sentiment was at record lows, and puts and shorts were at record highs. All the fuel necessary for another powerful bear market rally and a huge short squeeze. Now the question is - how long will this countertrend rally last? SPX 382 is likely.
Franc Fil
Franc Fil Oct 04, 2022 1:08AM ET
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1800 target on S&P500. Big earnings recession coming in the next few quarters. NKE and FDX are foreshadowing this. The index is very expensive!
Peter ONeill
Peter ONeill Oct 03, 2022 10:26AM ET
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Plus reviewing S&P based on PE ratios and then saying it is cheap - only if revenues remain at 2020 - 2022 levels. Revenue only reached these levels due to massive QE, cheap fed debt and stimulus cheques. We are only starting to enter a period of QT, High inflation, high-interest rates, tight labor, global tensions and global recessions. VERY VERY few companies will be able to maintain revenues at 2020- 2022 levels in 2023 ...which will mean the whole index will be repriced (I would suggest in Q4 earnings when companies give their forward-looking projections for 2023 and 2024).
Gonzalo Ribeiro
Gonzalo Ribeiro Oct 03, 2022 9:12AM ET
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Not only is the S&P not a bargain, but it's still overpriced and overvalued. I'm not getting back in until it hits 3000. I will continue shorting individual stocks, thank you very much
Charles Boon
Charles Boon Oct 03, 2022 9:07AM ET
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when the downward earning adjustment kicks in, the PE will be elevated, and the price will be down to maintain the current PE. the more earnings adjustment, the more price adjustment. 2nd wave of bear is already started. good luck
Ruben Chovet
Ruben Chovet Oct 03, 2022 9:01AM ET
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great article. thanks 👍
Peter ONeill
Peter ONeill Oct 03, 2022 8:52AM ET
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I wouldn't go near the S&P until under 3,000. Most of the major banks have dropped their targets to 3,300 - 3,800 now for the S&P by year-end (most predicted 4,600 - 5,400 at the start of the year for year-end). But they also say could drop to under 3,000 by Q2 2023 if a recession emerges in 2023. Historic trends seen in both 2000 and 2007 point to the S&P falling by approx 50% from its all-time highs if a recession does emerge - which would put the S&P at circa 2,400 over the next 12-18 months (March 2020 covid support levels).  Plus the Fed won't be able to step in to save the market without throwing the thoughts of controlling inflation out of the window.
Jan Chrapek
Jan Chrapek Oct 03, 2022 8:52AM ET
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As you see, the same people that were saying that it'll go higher when it was at the top are now saying that it'll go lower after 3 straight quarters of falling and many indicators suggesting that the bottom is near. These people are simply not reliable. Back in July it was enough that the Fed said "we will be more data dependent" for the S&P to shoot up almost 20% from roughly the same levels as now. Also, investors were euphoric when they heard that GDP declined for 2 straight quarters (a rule of thumb for recession) and stocks soared when big tech Q2 earnings were lower than expected and when inflation in July was at almost 40 year high. Some ETFs, like small cap growth (or even large cap growth) are still above their June lows and are forming a double bottom.
Erikke Evans
Erikke Oct 03, 2022 8:38AM ET
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Relativity. It's like using a rubber band for a measuring tape. No thanks.
Bukurosh Tahirllari
Bukurosh Tahirllari Oct 03, 2022 8:30AM ET
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Seth Amenyah
Seth Amenyah Oct 03, 2022 8:23AM ET
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Masa forget about history. Every moment is unique. Go ahead and buy, but don't come and disturb us with history.Are you a historian now?
 
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