A mini bull run in the S&P 500? Overvalued or undervalued?

S&P 500 Returns YtD dominated by the mega-cap tech stocks

Not exactly a mini bull run in US Stocks, as further examination illustrates.

The S&P500 currently trading at 4,096, and is just above the 150 day moving average of 4,027, 1.7% to be more precise. The 50 day moving average is just above that level at 4,035. Over this same period, there has been rampant inflation in the US, rising from 0.1% in March 2020 to 8.8% in May 2022. And the Fed Funds Rate has increased from 0.25% to 5% in March 2023. But stocks have not capitulated as much as commentators thought, but neither have they grown to such a bullish level to be a cause for concern.

Then there’s inflation, QT and interest rate rises

If we look closely at the data, the S&P 500 reached an exuberant post Covid level of 4,766, which is actually 16.4% above the current valuation. So in reality there was a correction after September 2021, conjunctively with the end of QE stimulus in the US. And since that period, inflation has not been so much as transient but a sticky tarmac of a road, embedding itself into food prices, energy, and wages. So QT took over, and interest rates have risen to 5% in the effort to stem inflation. But we are not in a bull run. The support levels are at c3,800, and anything less than that will essentially mean that some stocks become a bargain.

Source: Yahoo FInance

If we look at the portfolio of stocks in the S&P 500, the total market cap is c$37.2Tln. And the top 4 stocks, of Apple, Microsoft, Google and Amazon make up $7.4Tln or 20%, and the top ten stocks, which also include, Nvidia, Verizon, Tesla, Meta, Visa and Exxon, make up 30% of the total market cap. Analysts and commentators are concerned by this, but on closer inspection what is more important is if the valuations are close to where they should be?

Apple’s P/E ratio is currently 27x, which is less than the average sector P/E ratio of 42x. Does this mean that the stock is overvalued? No not necessarily, as they have nearly doubled their bottom line earnings from a substantial $55Bln to a staggering $99Bln from FYE’2019 to FYE’2022. Price to Earnings (using net income) is c26x. They’re forecast to have flatline growth over 2023 but a 5% growth rate in 2024. The question would be how low can the stock go, for it become cheap again? The answer is, there’s not much downside. The significant amount of liquidity in the stock holds too much sway. Vanguard, Blackrock, Berkshire Hathaway, State Street, and other mammoth ETFs hold substantial positions, pension funds are overweight the stock.  

Apple and Microsoft market cap combined of $4.8Tln is equal to the bottom weighted 270 companies in the S&P 500

S&P 500 Pharma Stock returns YtD

The pharma stocks have taken a battering YtD, with Pfizer down 23%, Johnson and Johnson down 7%, AMgen down 8%, Danaher down 9.7%. Eli Lilly, the manufacturer of Prozac and Methodone, has continued to perform well. The Covid vaccine providers have seen revenue fall this year.

S&P 500 Finance sector returns YtD

The finance sector has seen steady growth, and is less volatile than the tech and pharma components in the S&P 500. That is even with the current banking problems with the regional banks in the US. SVB, First Republic Bank and Signature bank collapses eclipsing the 2008 crisis, with total assets of $210Bln across just the three bank failures! The volatility is less evident in banking stocks in part due to the lower P/E valuations, averaging around 10x for the larger banks. Price to book valuations tend to be <1x.

In summary, one could argue that this is by no means a mini bull run, and the companies P/E ratios are congruent with the current level. And if the large tech stocks valuations are not excessive then the downside risk is currently fairly low. so the resistance levels at 3,800 are 5% below the current level, which should give some headroom if stocks fall. But then at that price level, valuations start to look cheap.


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