12/8/24

Weekly Market Recap

US stocks had another good week, notching a gain of 0.79% for the first week of December. This brings the S&P 500 to another all-time high. This excellent year for stocks has pushed the price-to-earnings ratio back up to 22.23x. The last time the market was this highly priced was at the end of 2021. Valuations during the dot-com bubble were slightly higher at 25.2x. While we are not at all-time highs in terms of valuations, we are close—in other words, US large-cap stocks are expensive. The average P/E ratio for the S&P 500 over the past 30 years was 16.83x. Therefore, if stocks were to reprice to their 30-year average valuation, that would represent a 25% drop in prices. However, the market doesn't typically make large moves without a specific catalyst. Stocks were expensive in late 2021, but the catalyst that caused a 25% drop that year was high inflation and rising interest rates. It's unclear whether a negative catalyst will emerge in 2025 to push stocks downward, as no one has a crystal ball. One key difference between now and late 2021 is the level of bond yields. In late 2021, the 10-year yield was around 1.50%, while today it sits at 4.15%. Bonds did not provide any protection in 2022 because the starting yield was so low. Since bond yields are at a much healthier level today, they are more likely to offer downside protection in the event of a future bear market in stocks. Therefore, if an investor is concerned about valuations in the US market, adding bonds might be warranted.

Chart of the Week

Although valuations of US stocks are nearing the levels seen during the dot-com bubble, I don’t want to suggest that we are in the same environment as the early 2000s. One key difference today is company profitability. This week’s chart shows the percentage of unprofitable companies during various periods over the last 25 years. Notice that 28% of large-cap companies were unprofitable during the tech bubble, compared to just 7% today. So while valuations are elevated, companies are making money. What also stands out on this chart is the percentage of unprofitable small-cap companies, which makes intuitive sense, as smaller companies are less mature and less likely to be profitable. A diversified portfolio should have exposure to small, mid, and large-cap stocks. Even though large caps have dominated for the past ten years, there have been periods in history where small and mid-caps have led the way.

Written by:

Ben Rones, CFA®

Senior Analyst at R&R Financial

The commentary in this newsletter is for informational purposes only and should not be taken as investment advice

Source: Compustat, FactSet, FTSE Russell, NBER, J.P. MorganAsset Management.

The S&P 500 is used for large cap. The Russell Mid Capis used for mid cap. The Russell 2000 is used for small cap. Data for thepercent of unprofitable companies in each index are from the followingquarters: Tech bubble = 4Q01, Financial crisis = 4Q08, COVID-19 = 1Q20 andCurrent = 3Q24.

Guide to the Markets – U.S. Data are as of December3, 2024.