Why the S&P500 is not actually overvalued

The Evolution of P/E Ratios in the S&P 500 Index

The average P/E ratio of the S&P 500 index is traditionally considered to be around 15, serving as a benchmark to assess whether American stocks are generally undervalued or overvalued.
However, this metric may not fully account for structural changes and market dynamics that have reshaped the financial landscape in recent decades.

The Correct P/E Ratio in 2024

As of 2024, what would be the appropriate P/E ratio to navigate the U.S.
stock market, and why might this parameter have increased?

One significant factor is the excessive concentration of market capitalization in a few tech companies.
In 2023, the top 10 holdings in the S&P 500 represented about 32.5% of the entire index, significantly higher than the 17.8% in 2015 and even the 27% during the peak of the dot-com bubble in 2000.

Tech companies typically command higher P/E ratios as growth companies with above-average growth rates and significant expansion potential.
This elevated growth potential justifies higher P/E multiples compared to more mature and less dynamic sectors.
Consequently, the prevalence of these tech companies in the S&P 500 has naturally raised the index’s average P/E, reflecting a higher “fair value” in the current context.

Excessive Liquidity in Circulation

Another factor driving an upward revision of correct P/E ratios for global companies is the surge in U.S.
public debt, which has far outpaced GDP growth.
To avoid a credit crisis and deflationary spiral, the Federal Reserve has resorted to debt monetization policies, injecting capital through quantitative easing.
This approach, emulated by other major central banks, has led to a substantial long-term increase in global liquidity.

This liquidity abundance has supported stock markets, keeping interest rates low and encouraging investments in higher-yielding assets like equities.
This scenario has contributed to maintaining elevated P/E multiples, without necessarily indicating excessive overvaluation.

The Future of the S&P 500’s P/E Ratio

In March 2017, the S&P 500 hovered around 2,300 points, with a mixed P/E of about 19.9.
Currently, the index has further grown, reflecting the strong performance of major tech companies and expansive monetary policy, reaching 28.77.
The question arises of how long this growth can continue.

Based on current economic cycles, central banks are expected to reduce their balance sheets and tame inflation by withdrawing liquidity from the system around 2026.
In this scenario, stock markets are likely to experience a correction, following the four-year pattern observed since the Global Financial Crisis (GFC) of 2008.