Stocks are so pricey, they’re reminiscent of the levels seen just before the dot-com bubble burst. The S&P 500’s market capitalization is currently just over three times stocks’ aggregate annual sales figure, according to Citigroup data. That’s even higher than in 1999, when it was just over two times—and that level was by far the highest seen between the early 1990s and 2020, before the Federal Reserve drastically lowered interest rates, boosting stocks’ appeal. But as both stocks and interest rates have run up this year, concerns over equity valuations are growing.
Yet investor sentiment remains enthusiastic enough to make the Citi strategists nervous. The bank’s panic-euopharia model, based on several data points, is still at its highest point on the chart, which dates back to 1987. The more euphoric the market is, the lower the returns will likely be going forward. The current reading suggests a negative S&P 500 return for the next year. Stocks are “getting into bubble territory,” Tobias Levkovich, Citigroup’s chief U.S. equity strategist, wrote in a note. “Euphoric readings imply worry if history is any guide.”
Don’t count on continued earnings beats to keep fueling stock gains. The percentage of upward earnings-estimate revisions peaked at 80% in 2020, the highest reading on Citi’s chart, which dates back more than two decades. The breadth of upward revisions has reverted to a more normal 67% of late.
Of course, it’s distinctly possible that this time is different. The speed of the economic downturn and recovery has been unprecedented, and it was caused by an event—a pandemic—few have seen before. It’s hard to consult past pandemics as a guide, but we can consult economic history. Credit Suisse strategists said recently that the historical correlation between gross domestic product and revenue growth suggests that S&P 500 sales estimates are still too low—and that should lift earnings estimates, too. Investors are already pricing in a healthy earnings stream.
While a pullback is certainly a possibility, that doesn’t mean the market is in a bubble.
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