After back-to-back 20-percent gains in 2024 and 2023, the S&P 500 is up another 12 percent this year. Its market cap is near $59 trillion. Several valuation multiples are either elevated or at fresh records, even as households’ equity allocation set a new high last quarter. There are no timing tools, but do inform us that excesses are piling up in the system.
 

Ahead of this week’s FOMC meeting in which the fed funds rate is expected to be cut by 25 basis points to a range of 400 basis points to 425 basis points, equity bulls last week rallied the S&P 500 to yet another high.

Up 1.6 percent for the week to 6584, with an intraday high of 6600 on Friday, the large cap index staged yet another breakout at 6480s, which had stopped bulls’ advance for four weeks (Chart 1). From the April 7^th low of 4835, the S&P 500 is now up north of 36 percent!

All along, bears have had their chances but consistently came up short. Most recently, seven weeks ago, a bearish engulfing candle developed on the weekly, but it was never confirmed; then, there was a hanging man four weeks ago, followed by a doji, and they too went begging.

Year-to-date, the S&P 500 is now up 12 percent. This follows gains of 23.3 percent in 2024 and 24.2 percent in 2023.
 

With this, the S&P 500 now boasts a market cap of nearly $59 trillion, up $9 trillion this year alone. This has made sure that its distance with nominal GDP kept getting wider.

At the end of the June quarter, S&P 500 market cap stood at $55.5 trillion, versus $30.4 trillion in nominal GDP, for a ratio of 1.83, which set a fresh record (Chart 2).

If past is prologue, when a bear market hits, the ratio has tended to go sub-one – at times well under unity.
 

For bulls’ defense, margins are holding up.

The last time S&P 500 operating margin dropped into negative territory was in 4Q08 during the financial crisis (Chart 3). During the Covid-19 recession, margins bottomed at 5.9 percent, before surging, subsequently reaching a new high of 13.5 percent in 2Q21.

For three years now, margins, even when under pressure, have tended to stabilize around 11 percent, or just underneath. The most recent bottom occurred in 2Q22 and 4Q22 at 10.9 percent. By the June quarter, this had expanded to 12.5 percent, which historically remains elevated.
 

This is perhaps why investors are willing to buy at the current elevated multiples.

In the just-concluded June quarter, on a trailing-12-month basis, the S&P 500 operating price-to-earnings ratio was 25.7x, which is very high. With two quarters’ earnings in, the sell-side as of last Tuesday has these companies bringing home $258.25 this year and $302.43 next. If this comes to pass, earnings would have grown 17.1 percent next year, which would follow this year’s expected 10.7 percent growth.

Granted these analysts tend to be optimistic at the outset and then bring out the scissors as time passes, markets tend to look ahead and are trading at next year’s elevated estimates. Even if this optimism is met, the P/E ratio drops to 21.8x by the fourth quarter next year, which is not cheap by any stretch of the imagination (Chart 4).
 

The price-to-sales ratio depicts the same picture. As a matter of fact, on this basis, the S&P 500 was trading at a fresh high of 3.1x at the end of the June quarter (Chart 5). This surpasses the previous high of just north of 3x in 4Q21. The ratio has persistently risen since bottoming at 2.1x in 3Q22.
 

And last but not the least, households’ equity allocation just established a new high last quarter – at 40.5 percent (Chart 6). This is so out of tune with previous bear-market highs that it looks crazy to be buying equity indices at these levels. But at the same time the same argument could be made a quarter ago or a few quarters ago. This alone obviously has not stopped bulls’ momentum.

With September halfway through, the S&P 500 is up another 6.1 percent in the current quarter; if these gains are kept, households’ equity allocation will certainly be at a new high. This is the problem with these metrics. These are not timing tools but point to excesses that are accumulating. Once momentum reverses – whenever that is – the pain trade can last a while.

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