As 2024 draws to a close, aside from this year's strong upward trend, many professionals are concerned about the overvaluation of the US stock market. But UBS doesn't seem to think so. The bank pointed out that the US stock prices are reasonable and will continue to rise.
For now, the expected P/E ratio of the S&P 500 index is 22.2 times, far higher than the average level of 16.8 times in the past 30 years, and close to the historical high of 25.0 times set during the Internet foam in 1999.
Wall Street strategists have repeatedly warned that such high valuations mean a pullback in the US stock market, and even a slight interruption could lead to a painful plunge.
However, UBS strategists led by Jonathan Golub stated in their latest report released on Monday that such high stock valuations are reasonable and will continue to climb next year.
They first pointed out that the dominant position of technology stocks in the S&P 500 index is increasingly strong.
Strategists explained that about 30 years ago, before the rise of the Internet and the emergence of smart phones, technology related companies accounted for only 10% of the market value of the S&P 500 index. Now, they account for 40%. At the same time, compared to other constituent companies, technology companies have faster revenue growth (approximately 11% vs 6%) and higher profit margins (24% vs 13%).
The result, not surprising, is a general increase in market valuations, "wrote UBS strategists.
Secondly, UBS analysts also stated that cash flows for both tech and non tech stocks have improved as their capital intensity has decreased. They added that the larger the cash flow, the more returns shareholders receive, which naturally helps stocks trade at a higher price to earnings ratio.
In addition, they also pointed out that the low discount rate is also one of the factors. At present, the yield of 10-year US treasury bond bonds is 40 basis points higher than the long-term average, while the credit spread is 220 basis points lower. Analysts say that these factors combined have led to a 20% decrease in the cost of capital compared to the historical average, which to some extent explains why valuations are so high.
Finally, UBS pointed out that valuations will rise during non recession periods, which means that valuations may continue to rise next year.
Due to the current risk of recession being controlled, the price to earnings ratio is likely to rise in 2025, "they wrote.
UBS's latest analysis undoubtedly dispelled many market observers' biggest doubts. Overall, investors are still very optimistic about the trend of the US stock market next year. Last month, the news of Trump's election victory provided a new catalyst for the rise of the US stock market, igniting hope for sustained profit growth brought about by reduced regulation and lower taxes.
UBS pointed out in a previous report that this period of prosperity, marked by strong economic growth and market returns, may continue until 2025. In the most optimistic scenario, the S&P 500 index is expected to rise to 7000 points next year.
The bank stated that the expectation of the 'Roaring Twenties' has emerged.