By Tim Courtney, Chief Investment Officer at Exencial Wealth Advisors
During the past six weeks, the S&P 500 crossed 5,000 for the first time and remained above that threshold1, while the Nasdaq hit a new all-time high of 16,274.94 on March 12. Across the pond in Europe, the GRANOLAS stocks (people love making acronyms out of company names) also led the STOXX 600 index to a historic peak3. These record highs often raise questions from investors: Is this cause for celebration, or should we brace for a downturn?
The answer is that our current circumstance of markets at new highs is normal and that market highs are not by themselves a cause for excitement or concern. Historical data reveals that about 30% of all month-end valuations are new all-time highs. As such new highs are not rare, which is good because investing in markets which go decades between highs is not very fun.
Seeing a new high in markets also doesn’t give us insight or more accurate predictions on what future returns will be. Our research indicates that market returns following record highs are similar to returns following any other market period. Market performance after a new market high or even after a 20% decline is on average about the same – roughly 10% annualized returns over the next three and five years4. Just because a market reaches a new all-time high doesn’t mean we should expect much different future expected returns.
What we should be paying attention to, however, are the prices we're paying for stocks during these highs. Are these new highs supported by solid fundamentals like earnings growth and a strong economy? Are investor expectations for future growth and risk reasonable, or are they overly optimistic? In other words, do stock prices appear expensive relative to their fundamentals and future growth potential?
When we evaluate the price of markets, we want to look at price scaled by some fundamental measure. We might look at price/earnings, price/book value or price/cash flow. If markets are hitting new highs while the economy and earnings are growing well, that is healthy and expected. But if markets are hitting highs and prices and moving higher than the fundamentals, that may not be as healthy. We need to examine why that might be happening.
Currently, broad markets don’t seem overpriced. But, there's a noticeable sliver of the market, within US large companies, within the tech/communications sectors, especially within AI related names, that does look pretty expensive5. Prices in some of these companies are growing faster than their earnings and assume extremely optimistic future growth. This is something that we are concerned about because while history doesn’t have much to say about markets hitting new highs, it does indicate that after valuations become elevated, future returns tend to be lower.
When you see headlines highlighting that markets hit a record high, remember this is a fairly common occurrence and the reason we invest. We do however want to remain disciplined about how we invest and the prices we pay for the assets we own.
Sources
- MarketWatch - S&P 500 index overview (3/12/24)
- Reuters - S&P 500, Nasdaq close at fresh records on AI boost, easing yields (3/1/24)
- Reuters - Europe’s STOXX 600 at all-time high as Nvidia boosts global tech shares (2/22/24)
- Exencial Wealth Advisors - Markets at record highs (2/27/24)
- Investopedia - Investors have piled into ‘Magnificent Seven’ stocks—why that may not be good (2/13/24)
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