April 16, 2024

Source: Montag & Caldwell, FactSet.

PVT=Present Value Total; P/PVT=Price to Present Value Total and represents our estimate for the S&P 500’s price relative to our estimate of its intrinsic value.  ERP stands for equity risk premium.  ERP is calculated by subtracting the 10 year Treasury Yield from the earnings yield for the S&P 500.  ERP is the additional return that investors would expect to earn by investing in the stock market over a risk-free asset.  This premium compensates investors for the higher risk of investing in stocks.  Monthly data as of March 31, 2024

While the economy continues to display impressive momentum, and inflation should soon resume its downward trajectory, these fundamentals seem to be more than fully reflected in valuations.  The S&P 500 is currently trading at 21x forward earnings (19% higher than its ten year average), implying an equity risk premium of just 54 basis points, which is historically low.  Furthermore, our proprietary calculation of price-to-present value for the market currently sits at 136%, higher than any other time outside the late 1990’s technology bubble.  These elevated valuations seem to reflect investor expectations for a best-of-all-worlds period of strong growth and Fed rate cuts.  We remain skeptical that investors will get both.

We believe it is unrealistic to expect the Fed to begin cutting rates when the economy is performing so well, unemployment is so low, inflation remains above target, and asset prices continue to surge higher.  A premature easing by the Fed would run the risk of excessive speculation, which would then require more damaging corrective actions.  Combining elevated valuations with investor surveys showing excessive bullish sentiment, we believe the preconditions are now in place for a long-overdue 5-10% correction, which could occur at any time.  Anything more detrimental than that would likely require a recession-induced decline in corporate profits, which we currently do not see, but cannot rule out due to ongoing quantitative tightening, contraction in the money supply and a yield curve that remains inverted.