Savita Subramanian of Bank of America said in a letter to investors on Wednesday that while the stock market "is egregiously expensive" compared to its past, it shouldn't put them off investing in stocks.
Although the S&P 500 is "statistically expensive on 19 of 20 metrics and is trading at a 95th percentile price to trailing earnings ratio based on data back to 1900," the US equities analyst said that this does not rule out further price increases for stocks, and he had a point.
The comparison of present stock market values to those of the past, when the makeup of the S&P 500 was very different, was particularly problematic from Subramanian's point of view.
According to Subramanian, "the idea that the market is too expensive" is one of the many bearish arguments that he wants to disprove, as he stated on Wednesday . There will be comparisons made between today's S&P and its performance ten, twenty, thirty, and forty years ago. The modern market is a whole different beast, therefore I don't see how it makes sense.
The price-to-earnings ratio for the S&P 500 is 24.5x over the past 12 months, which is much higher than the 21.1x average for the past 10 years. A projected price-to-earnings ratio of 20.4x for the S&P 500 is over one standard deviation higher than the average of 16.6x for the past 30 years.
But maybe the S&P 500 should be worth more than it was thirty years ago, given that the firms that make up the index are substantially more lucrative now than they were then, says Subramanian.
The S&P 500 is less volatile in profits, has better quality, and is half as levered as it was in previous decades. She elaborated on the index's change from being 70% asset-intensive in 1980 (in the manufacturing, finance, and real estate sectors) to 50% asset-light in Tech & Health Care today. Profit margins for the S&P 500 have increased from 6% in the 1980s to over 12% now, reflecting this change in composition.
"We're in a different ball game here so you can't just look at the S&P today and take that P/E and compare it over time. In sum, stock prices will probably keep heading upwards despite the historically high market valuations so long as corporate earnings don't fall from where they are.
According to Subramanian, "this realistic good case scenario suggests a fair value for the S&P 500 of ~5500," which may constitute a 9% increase from where it is now.
stay turned for development