Stock Market Valuation - What it is. What it is not. And Why We Care.
Most folks want to talk about recent returns. That’s fine. Returns have been good in 2024 so far! But what we should expect going forward is always harder to say (because we are predicting the future, which is hard) but important to contemplate as it relates to portfolio positioning. With the benefit of hindsight, I believe one can easily look at the chart below (Figure 1) and circle where they wish they would have invested more (at the lows) and where they would have taken some gains (at the highs). But in the moment, as in now, is the top we are at an inflection point or just another step higher in a continued move to the real top?
Figure 1 S&P 500 invest at inflection points[i]
Figure 2 also seems to indicate we are nearing the top of the range in terms of S&P 500 valuations as measured by forward PE ratios.
Figure 2 S&P 500 Valuation Measures[ii]
What Figure 1 and 2 tell us is that on average stock market valuations (price to earnings ratios or PE ratios) and prices seem to be high relative to average. What they do not tell us is that we are a market top. These are not market timing tools. So, knowing what they are and what they are not, why do we still care? Figure 3 helps to answer that question but is still not perfect. Figure three relates current valuations to subsequent 1- and 5-year returns. In summary, the higher the current valuation of the stock market as a whole, the lower the future expected returns and vice versa, the lower the current valuation, the higher the future returns.
Figure 3 Forward PE and subsequent 1 year returns[iii]
So, our take. Don’t expect the 1 and 5-year returns to be as good as the previous 1 and 5-year returns, approximately 27% and 15% (annualized), respectively. But you also should not run for the hills. Maintain an appropriate equity exposure but consider rebalancing some of the recently experienced above-average returns into other opportunities. As for those opportunities, that is a story for your upcoming review meetings. Looking forward to it!
[i] Source: Compustat, FactSet, Federal Reserve, Refinitiv Datastream, Standard & Poor’s, J.P. Morgan Asset Management.
Dividend yield is calculated as consensus estimates of dividends for the next 12 months, divided by most recent price, as provided by Compustat. Forward price-to-earnings ratio is a bottom-up calculation based on IBES estimates and FactSet estimates since January 2022. Returns are cumulative and based on S&P 500 Index price movement only, and do not include the reinvestment of dividends. Past performance is not indicative of future returns.
JP Morgan Guide to the Markets – U.S. Data are as of June 30, 2024.
[ii] Source: FactSet, FRB, Refinitiv Datastream, Robert Shiller, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.
Price-to-earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months as provided by IBES since March 1994 and by FactSet since January 2022. Average P/E and standard deviations are calculated using 30 years of history. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as the next 12-months consensus dividend divided by most recent price. Price-to-book ratio is the price divided by book value per share. Price-to-cash flow is price divided by NTM cash flow. EY minus Baa yield is the forward earnings yield (consensus analyst estimates of EPS over the next 12 months divided by price) minus the Moody’s Baa seasoned corporate bond yield. Std. dev. over-/under-valued is calculated using the average and standard deviation over 30 years for each measure. *Averages and standard deviations for dividend yield and P/CF are since November 1995 due to data availability.
JP Morgan Guide to the Markets – U.S. Data are as of June 30, 2024.
[iii] Source: FactSet, Refinitiv Datastream, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.
Returns are 12-month and 60-month annualized total returns, measured monthly, beginning 6/30/1999. R² represents the percent of total variation in total returns that can be explained by forward price-to-earnings ratios. Price-to-earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months as provided by IBES since May 1999 and by FactSet since January 2022.
JP Morgan Guide to the Markets – U.S. Data are as of June 30, 2024.
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Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.
Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.
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