- S&P 500 valuations are historically stretched. One strategist says it’s just the new normal, not a reason to sell.
- The index’s structure has evolved, with less leverage, higher quality earnings, and more efficient companies.
- Technological upgrades and service-oriented firms may drive a productivity boom.
The S&P 500 is hitting valuation extremes. But one Wall Street strategist says that’s simply the new normal, and not a screaming signal to sell.
Instead, investors should embrace the high historical valuations because the internal makeup of the stock market is a lot different than it was a few decades ago, according to Savita Subramanian, equity strategist at Bank of America.
“The S&P 500 is a different animal than in prior cycles,” Subramanian said in a note on Friday.
The strategist highlighted that of the 20 valuation metrics she tracks, 19 are sitting at extreme levels. For example, the S&P 500’s trailing price-to-earnings ratio of 25.3 times is 70% above its 125-year average of about 15 times.
But the high valuations are justified and are probably here to stay, according to Subramanian, who highlighted that today’s S&P 500 is less levered, higher quality, and less asset-intensive than in the past.
"Companies adapted to more expensive input costs post-COVID by spending on efficiency," Subramanian said. "Improvements are well underway."
Those improvements, which include technological upgrades related to AI and automation and more efficient labor spending, should lead to a boom in productivity not seen in decades.
"This rhymes with what we saw in the early 80s efficiency boom, and today's ERP is close to average levels during the 80s/90s and nowhere near the negative levels we saw in 2000," Subramanian said.
Subramanian also finds the service-oriented nature of the businesses within the S&P 500 encouraging. Whereas the S&P 500 was 70% exposed to the manufacturing economy in 1980, today's index has 50% exposure to asset-light companies specializing in innovation.
And those types of companies should help unlock a productivity boom, which ultimately helps drive more stable earnings that are less prone to the ups and downs of cyclical swings.
"Replacing people with processes improves EPS visibility," Subramanian said, adding that more visible earnings warrant higher valuations.
Subramanian set a 2025 price target of 6,666 for the S&P 500, representing potential upside of 14% from current levels.