March 2024 -Is the Market Overvalued?

This morning, we received the February Nonfarm payroll report (i.e. jobs/unemployment report) that showed the U.S. economy added 275,000 jobs last month – which was better than the 200,000 economists expected. The unemployment rate rose to 3.9% in February after holding at 3.7% for three straight months, while wage growth slowed to 0.1% on a monthly basis.

For those of you who are not economists, this morning’s jobs report was just what the market wanted to see, a nationwide labor market that is tight and healthy, wage growth that is increasing but not increasing so quickly that it’s inflationary, and negative revisions down in jobs added in January which ironically, is a good thing as this data also indicates a labor market that is growing but not so quickly that it’s inflationary.

This is fertile ground for the bull market and more evidence that the Federal Reserve has managed to thread the needle with monetary policy by slowing the economy down, reducing inflation, without tipping us into recession -bravo. This is known as a “soft landing” and the Federal Reserve has managed to do this only once in the past 50 years so as it stands right now, we are in rarified air.

As I have mentioned in past notes, the stock market is a forward-looking mechanism and stock prices and current sentiment are reflecting further gains ahead. In fact, when the S&P 500 has been up in January and February, it has gained an average of 11% over the rest of the year and was higher in 26 out of 28 cases. Our January note was titled “A more supportive economic environment” and we are quickly moving towards this with a lower, more accommodating interest rate environment.

We now believe the first Federal Reserve interest rate cut of .25% will be announced on June 12th with further .25% cuts coming in each of their July, September, November and December meetings. Remember, a lower interest rate environment is a boon for corporations and consumers as it makes borrowing less expensive, which for corporate America, ultimately trickles down on their balance sheet to an increase in profit margins which in turn result in increased earnings per share, which is the true driver of higher stock prices in the long term.

Given the markets gains experienced in 2023, and the continued gains we are seeing year to date, we have to ask ourselves is the market “overvalued” and prone to a correction? The answer is yes and no. For example, the S&P 500 Index is currently trading at a forward P/E (price to earnings ratio) of 23. The historic average for the index is 19.75 -but we would like to point out, that the Magnificent 7 (Apple, Amazon, Google, Microsoft, Nvidia, Tesla and Meta) account for 30% of the weighting within the S&P 500 Index.

Do these seven companies deserve to be trading at a higher valuation than their peers? We believe so, given their fortress balance sheets, massive free cash flow, protective motes around their business and prospects for continued future revenue growth. If we remove the magnificent 7 from the S&P 500 Index, the index (or the other 493 stocks) are trading at a forward P/E of 16.5 which is below the historical average.

This leads us to believe that further share price growth on the Magnificent 7 from here will be muted (in the short run) but there is plenty of room for share price growth from the other 493 S&P 500 companies -which we own within our portfolios too.

Tactically, we would like to see the equities market pump the brakes a bit and we should expect a modest -5 to -10% correction could occur at any moment. Remember, it is normal and healthy for markets to experience at least one -10% dip each year and roughly three -5 to -9% dips throughout any one year. Geopolitical tensions, an unexpected rise in inflation and a divisive presidential election now just eight months away could be upcoming drivers of the next short term sell off.

Given portfolio performance year to date, if you foresee yourself needing a material withdraw ($20k or higher), from your portfolio, please reach out as raising cash sooner rather than later makes a whole lotta sense.

As always, we wish you and your family a great Friday evening, and a wonderful weekend!

Please reach out to us with any questions or comments you may have regarding your specific situation.

 

Jaran C. Day, Chief Investment Officer

Griffin Dalrymple, CFP®, Chief Strategy Officer

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