Other than to some headline writers and manufacturers of commemorative hats, it doesn’t mean much when market indexes reach big, round numbers. These milestones would probably not be worth noting at all if they didn’t offer a handy chance to compare the market with prior visits to the same place.
The benchmark Standard & Poor’s 500 index is within a flutter of reaching 1,500, a level it attained only twice before on the way up, in March 2000 and May 2007. Both earlier trips culminated in an ultimate bull-market top within a handful of months and a few percentage points of additional upside. That’s a coincidence worthy of mention, without holding any clear guidance on where the market is likely to head from here.
An index is an ever-evolving, human-contrived thing. Even though the S&P 500 of today captures roughly $13 billion in market value, just as it did those prior times it traded at 1,500, today’s iteration envelops a somewhat disparate selection of companies in wholly differing proportions, operating in quite distinct economic conditions. (Never even mind the important fact that inflation has made those 1,500 points worth less in real terms than in 2000 or 2007.)
Tale of the tape
Still, lining up today’s S&P 500 at 1,500 with the earlier versions and setting them against the fundamental underpinnings at the time can offer an informative tale of the tape.
How it got there: On the first run to 1,500, the S&P’s achievement was barely worth noting, given that the market had been notching new all-time highs for years in the final irresistible sprint of the greatest bull market in history.
The immediate bull run that sent the S&P above 1,500 amounted to a 62% gain in less than a year and a half. That qualified as plodding at the time, given the Nasdaq Composite was in the process of doubling over the span of seven months.
The return to the 1,500 level in May 2007 was a less exuberant journey, having climbed 95% in four years and seven months from the fall 2002 low. It was pushed higher by the temporary financial and consumer bounty of the housing bubble and the commodity boom – which owed to the ultra-low interest rates of the early 2000s. The market trudged another 5% higher by October even as the subprime mortgage market was cracking, before things began to fall apart chaotically in ’08.
The current bull market has been peppier, rising from lower depths and formed in the hotter crucible of the financial crisis and extraordinary official efforts to rescue the system. The benchmark is up 120% six weeks before the bull market will turn four.
Valuation: In 2000, the market was vastly overvalued, with bubble-grade multiples on largely illusory or over-inflated corporate profits. The S&P traded at nearly 30-times the prior year’s earnings when it got to 1,500, and the total U.S. stock market was worth a towering 180% of U.S. gross domestic product. This excessively expensive starting point largely explains the subsequent decade’s negative return on stocks. At the time, 10-year Treasuries yielded better than 6%, offering an excellent alternative for the few who saw it as such at the time.
In 2007, the market was at 18-times earnings, higher than the historical average of around 15, and a touch higher than the present P/E of 17-times the past year’s reported earnings.
By these gauges, the present valuation is neither enticingly cheap nor resoundingly expensive. If 2013 analyst forecasts are reached, which is no sure thing, the market is at a forward multiple near 14, still above average but in a zone where valuation would neither be an impediment to additional upside nor a comforting cushion to absorb any economic setbacks.
At least two things stand out as supportive factors for today’s S&P 500 at the 1,500 mark. First, today’s market contains fewer obvious imbalances. The 2000 market was distended nearly beyond recognition by the bubbly values, silly business models and capital destruction of the tech sector. In 2007, financial earnings had peaked near 40% of total index profits, and they’d soon be reversed as massive credit losses in the bust.
Today, the market isn’t clearly dependent on a single sector. Seven of the S&P’s 10 industry sectors today account for at least 10% of the index’s market value each, compared to five in 2007 and three in 2000. True, low rates are the common prop to profits in the consumer area and have slashed borrowing costs for all companies, but low rates are also penalizing financial-company profits.
Second, the moderate richness of stock valuations today stands as part of an asset spectrum that is expensive nearly across the board.
Treasury yields are below 2%, corporate debt rates are near half-century lows, real estate investment trusts are thoroughly picked over. This all comes from zero-rate policies at the Federal Reserve and its global counterparts, and the Fed’s steady liquidity injections keep its posture easy.
In 2000 the Fed was eight months into a rate-boosting campaign to prevent economic overheating. In 2007 the Fed had just begun trimming rates after having lifted them high enough to fracture the housing market and usher in a recession.
That stocks’ above-average valuation now is understandable does nothing to help the prospects for equities' absolute returns in the coming decade or so. But it does mean stocks are not anomalously overvalued now.
One final contrast: In 2000 and 2007, unemployment was below 4.5% and the main concern was forestalling inflation and over-investment. Today the jobless rate is 7.8% and there is urgency to foster quicker growth. That could mean the economic margin for error is thin for investors in profit-seeking companies, or that the liquidity tailwind won’t go away for a long while.
Or, quite likely, both.