Are US stock valuations too high? There may still be room for growth in the next year!

The outstanding performance of the US stock market in the past 18 months has given investors many reasons to celebrate, but it has also burdened them with some of the most expensive valuations in recent years. The high prices of US stocks relative to fundamentals such as earnings have made some investors, including hedge fund star David Einhorn, cautious about putting in more money. However, according to analysis by the Leuthold Group, there is no reason why investors' good times cannot continue for at least the next 12 months. In a report earlier this month, Leuthold studied the historical performance of the S&P 500 index after it rose by 30% or more in the past 12 months. This is roughly in line with the recent market gains. According to FactSet data, the S&P 500 index rose by 33% in the 12 months ending October 1. Since hitting a bear market bottom in October 2023, the index has risen by over 60%. Historically, such above-average returns often continue for at least the next 12 months. During this period, the average performance exceeded 13%, far higher than the typical return for all 12-month periods since 1926. In other words, short-term trends often surpass valuation concerns. The report's author, David Ramsey, portfolio manager and chief investment officer at the Leuthold Group, wrote: "Trends often beget more trends, with the S&P 500 index averaging a 13.8% increase in the 12 months following the first +30% threshold." However, over a longer time frame, high valuations will have a greater impact. While the correlation between valuation and future returns over any one-year period is only -0.19, when the Leuthold Group extended its analysis to 7 to 10 years, they found this inverse relationship became more pronounced. Another factor to consider is that valuations have not typically been as high as they are today. According to Ramsey's calculation of the S&P 500 index's standardized earnings per share, as of the end of September, the S&P 500 index had a price-earnings ratio of 31.4 times. This is the highest level in any period included in Leuthold's analysis, although data from March 2021 and June 1997 were also close. Across Wall Street, analysts are increasingly focusing on the market's lofty valuations, issuing client reports warning that future returns over the next decade could significantly weaken. A recent report from Bank of America said that the high standardized price-earnings ratio of the S&P 500 index could result in an annualized return of only 1% over the next ten years. This is even worse than the 3% predicted by the Goldman Sachs analyst team earlier this month. However, the BofA team also offered a glimmer of hope: the equal-weighted S&P 500 index (SP500EW) is more attractive than the market-cap-weighted S&P 500 index. This may help its performance over the next decade In fact, if large US companies continue to increase dividends, the equally weighted S&P 500 Index may achieve an annual return of 8% in the near future