S&P 500 Forward Price/Earnings Analysis

The last decade has been a strong one for U.S. equities and bonds. One primary driver of that performance were low starting valuations, stemming from the Great Recession, which had just ended in 2009. This was the opposite of the scenario that led to the lost decade preceding it. I believe many market participants are setting the table for a future lost decade by chasing short-term performance and ignoring valuations.

On January 3rd, 2000, the S&P 500 traded at 1455.22. Valuations were extremely high, as the Tech Bubble was still in full force.10 Years Later, the S&P closed at 1115.1, representing a completely lost decade for U.S. stock indices. Of course, specific stocks did very well, but even the bellwether names such as Microsoft MSFT, Cisco CSCO, and Intel INTC, faired very poorly, despite strong earnings growth over the decade. Other asset classes such as Emerging Markets and European stocks held up much better, as they came into the period at much more reasonable valuations. Paying too much, even for great companies, can lead to very poor returns.

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After the Tech Bust and the Great Recession occurred over a 10-year period, investors entered the following decade with a gun-shy approach to equities. Other sectors such as commodities like gold/oil, or alternative assets such as REITs/MLP’s, were becoming more popular. Fast forward eleven years, and the S&P 500 has risen from 1115.1 to 3703.06. The pessimism reflected in prices going into the period drove stronger investment returns, while the optimism and high valuations from 2000 drove the poor returns.

Despite the Covid-19 pandemic, associated lockdowns, and substantial recession, equities once again are priced with immense optimism. Technology stocks once again are leading the way like they did into 2000, as companies such as Apple, Amazon, Zoom, and Netflix benefited when many other areas of the economy were shockingly closed down. As these companies have grown in size, the S&P 500 has become more concentrated among the top names than it has ever been. This has helped index fund investors as these stocks outperformed the average stock and especially value stock, by a large margin this year.

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