Following the 2022 bear market, where the S&P 500 dropped 19% and the Nasdaq Composite fell 33%, it seemed that the market had indeed corrected, bringing prices back down closer to their recent historical ranges.
Historically overvalued in the post-pandemic run-up, the S&P 500 climbed 29%, 16% and 27% in each year between 2019 and 2021, while the Nasdaq gained 35%, 44% and 21% during the same years.
However, the markets have rebounded this year, with the S&P 500 up 18% and the Nasdaq up 36% year to date (YTD). The technology and communication services sectors lead the charge, with both up more than 50% YTD. This raises the question of whether the market, especially the tech sector, has become overvalued again. Let’s take a closer look.
Two years since the Nasdaq’s high
The S&P 500 hit an all-time high of 4,797 on Jan. 3, 2022, and has since dropped about 4.6% to around 4,547 on Nov. 21.
The Nasdaq hit its all-time closing high on Nov. 19, almost exactly two years to the day, closing at 16,057. It hit its intraday all-time high of 16,212 on Nov. 22, 2019, as the bear market started earlier for technology stocks. Since then, the Nasdaq is down about 12% to 14,284 as of Nov. 21.
Considering the significant total returns leading up to those highs, the declines seem relatively small. The S&P 500 gained 96% from the market opening on Jan. 2, 2019 to its January 2022 all-time high, while the Nasdaq rose 130% leading up to its November 2021 all-time high.
This indicates that the recent declines for these benchmarks are minor compared to the gains leading up to them.
Let’s examine a key metric to evaluate valuations: the price-to-earnings (P/E) ratio.
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Shiller P/E ratio still above normal
Like the P/E ratio for evaluating individual stock valuations, it is also used to measure index valuation by comparing stock price to earnings. The P/E ratio looks at numbers over the last 12 months, while the Shiller P/E ratio, named after economist Robert Shiller, looks at earnings over the previous 10 years, factoring in inflation for a long-term view of earnings power.
Currently, the Shiller P/E ratio is about 30.7, which is historically high but lower than the recent high of 37.4 in June 2021. The regular P/E ratio is currently around 25, higher than its January 2022 reading of 23 but lower than the 39 reading in December 2020.
Where are we now?
All these numbers suggest that the market is still overvalued but not at the levels seen during the 2021 technology bubble. This could indicate that major indexes will experience a bit of a correction in 2024 or have low growth, as many analysts are predicting. Investors should keep an eye on valuations and consider broadening their portfolios to include small and mid caps and value stocks.
