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S&P 500 Due for Major Correction as Valuations Soar to Unprecedented Levels

Last Updated September 23, 2020 1:33 PM
Kiril Nikolaev
Last Updated September 23, 2020 1:33 PM
  • The S&P 500 remains bullish as the index continues to keep bears at bay.
  • Nevertheless, one portfolio management firm says that the bear case is now stronger than ever due to record valuations.
  • Other analysts are not yet ready to press the panic button.

The S&P 500 (SPX) continues to show its might. The index was up 27.2 points Thursday as bargain hunters welcomed the dip. Technical signals reveal that the SPX is no longer overheated and that it may resume its uptrend soon.

But the fundamentals are telling a different story. Many stocks continue to trade in overbought or extreme overbought conditions. One portfolio manager discovered that the percentage of sectors at record valuations has reached a level not seen in both the tech and housing bubbles.

Eight of 11 S&P 500 Sectors at Record Valuations

In a letter to investors, Crescat Capital notes  that the bear case for U.S. equities has never been stronger. The portfolio management firm sees the coronavirus as the catalyst that can push overvalued stock markets to their breaking point.

Crescat Capital says that the median to EV sales for the index has reached “an insane, euphoric level of 3.6 times, two times than the tech bubble peak.” Here’s a chart that visualizes the point of the portfolio management firm.

Percentage of sectors at record valuations
Percentage of sectors at record valuations. | Source: Crescat Capital 

The median enterprise value to sales metric offers a very good picture of the magnitude of the stock market bubble. Enterprise value  [Investopedia] for a company is calculated by adding market cap and debt and subtracting cash and equivalents. Median EV to sales is a more accurate valuation metric because it accounts for company debt.

In addition, Crescat Capital stressed that,

An unprecedented 8 out of 11 sectors are at top-decile, historical valuations illustrating the breadth of the current market excess.

Here’s another chart that illustrates the record valuations of S&P 500 sectors.

Bargain hunters, consider yourself warned
Bargain hunters, consider yourself warned. | Source: Twitter 

Crescat Capital’s Otavio Costa warns that the coronavirus is just the tip of the iceberg. He told CCN.com that China’s credit imbalances can affect U.S. equities:

China is dealing with a $40 trillion banking system facing significant deceleration of GDP growth, rising inflationary forces, and a declining current account problem. The likelihood of a debt crisis in China would be largely contagious to the global economy and could severely impact US markets at the late stages of its business cycle.

Crescat Capital may be right: the bear case may be stronger than ever.

Other Analysts Not Yet Pushing the Panic Button

While there’s a divergence between fundamentals and price, many analysts remain bullish on the U.S. stock market. JM Vala, co-founder of Layup Trades, is a steadfast bull. He says that dips are opportunities to enter the market at a discount. He told CCN.com,

The trend is bullish. It has been bullish, and will be bullish until the end of the business cycle. All pullbacks are opportunities to add or create new longs, and that’s how all dips should be treated until volume nodes no longer are supportive of price.

When asked for key levels to watch out for, the trader replied,

For the market to move higher, we will need to see SPY hold above 329, which is the 61.8% retracement of the pullback. So long as the market continues to hold 320-322, then we will continue to have violent pullbacks and major expansions higher.

If we’re basing the market purely off technical indicators, valuations don’t seem to matter presently. However, we are already getting signals that valuations will matter soon. When that time comes, we may see the S&P 500 plunge like never before.

Disclaimer: The above should not be considered trading advice from CCN.com. The writer does not own any shares of the companies, ETFs or markets mentioned.