Market comment on behalf of Hani Abuagla Senior Market Analyst at XTB MENA
It can be said that this year is practically behind us, even though there are still a few days left until the end. But I think we can start to take stock of what 2024 was like from an investment perspective. In short, it can be said that it was definitely a good year for most people, as almost all important global stock indexes grew nicely and the cryptocurrency market, for example, grew significantly. The most famous stock index is clearly the American S&P 500, which brings together the shares of the 500 largest American companies that are in profit, or had to be in profit for 4 consecutive quarters before entering the index. This index has added 24% since the beginning of the year, which is well above average (the long-term average is approximately 10% per year) and grew approximately the same last year. Over the past 2 years, the index has added more than 45%, so anyone who started investing in the past 2 years has experienced nice growth in the market. The technological Nasdaq is growing even a little more, specifically by 26%. However, some European indices have also done quite well (despite a much worse economic situation). The German DAX grew by 20%, the British FTSE by 6%, the French CAC, however, fell by about 2% due to the accumulation of several domestic or foreign macro problems. The Japanese Nikkei also grew by 16%, similar to some Chinese indices. The global stock index, where the American market has about two-thirds of its weight, grew by a good 17%. Bitcoin, however, has had an even better year, with its price increasing by 140%. Its price was driven up by, for example, the halving, the approval of spot Bitcoin ETFs, and the election of the cryptocurrency-friendly Donald Trump as US president.
So at first glance, everything looks ideal, but the current situation shows several interesting things from a historical perspective. The basic indicator of whether stocks are expensive is the so-called P/E ratio, which compares the price and earnings of a stock. The higher the value, the more the investor pays for a dollar of profit and vice versa. Currently, this value for the S&P 500 is at 26 times annual earnings. If we do not count the short-term Covid scattering of company profitability, the last time such a high value was on a given market was about 25 years ago during the dotcom bubble. In other words, American stocks are the most expensive in about 25 years. This fact is even more interesting in the context of the fact that stocks in the rest of the world are not nearly as expensive. If we look at the world stock index, from which we remove stocks from the USA, we get to a value of 15 times annual earnings, which is approximately the average value of the last decade. The difference between P/E of SP500 and rest of the world you can see on picture below. Stocks in the rest of the world are at some long-term average, while US stock valuations are at an all-time high.
But why is the US market so expensive and what can it mean for investors? In the long term, the growth of stocks is mainly driven by the growth of companies’ profitability, or expectations of future profit growth. The profits of the S&P 500 index are growing by approximately 9.5% this year, last year it was 8.5%, so profitability is growing, but at a slower pace than the shares themselves. For the last 2 years, the market has been experiencing AI mania, which is the main driver of the growth of the US market. The shares of technology companies, such as Nvidia, Alphabet, Microsoft, Amazon and Tesla, are significantly increasing. These companies are expected to continue to see significant growth in sales and profitability in the coming years, so in simple terms, investors are currently betting that technology companies in particular will earn even more in the future. Whether they will succeed or not, of course, no one knows, but Big Tech pretends that AI is an opportunity that comes only once in a generation and many of them compare it to the emergence of the Internet and invest literally hundreds of billions of USD in AI infrastructure in the form of servers and chips every year. If AI meets expectations and companies start earning even more thanks to it, such a high valuation makes sense. But if the path is more complicated, then the shares are simply expensive. Unfortunately, none of us can see into the future and we will probably have to wait at least a few more years to find out which version is the right one. The growth of shares towards the end of the year was also helped by the election of Donald Trump, from whom a more friendly policy in the field of business and changes for the better in the field of taxes and regulations.
But what do expensive markets mean for investors in practice? It probably makes no sense to try to predict future developments based on feelings. However, there are a few numbers and data that we can at least take a little cue from. For example, history shows us that two years in a row with such high growth are relatively atypical and are often followed by weaker years, or even in the red. The valuation of shares themselves can also tell us something. We only have data on index valuations for a few decades, but based on them, in the past it was true that with such high valuations, the real return on shares was slightly negative for the next 5 or 10 years. However, it should be added that shares have not been this expensive many times in the past, so this is not a large sample of data. A similar analysis (but probably with more data) was also done by JP Morgan, which looked at expected profits, and the conclusion was similar, namely that with an expensive market, returns in the coming years are weaker, on average zero over a one-year horizon and about 1-2% over a five-year horizon (picture below).
The fact that returns in the next decade will be weaker than they were in the last decade is also expected by large American banks, which continuously issue their forecasts. Goldman Sachs is talking about an average annual return of 3% for the next 10 years, JP Morgan sees a return of 6% per year. Of course, even banks do not know how the stock market will develop and how, for example, large technology companies and their businesses in the field of AI will do, but it may tell us something that the returns we have experienced in recent years will probably not be the standard every year in the next decade, or at least these large institutions are not counting on it.
Either way, we will see the reality only with time. The beauty of long-term investing is that if you have a 20-30 year horizon, you will most likely (at least based on data for more than 100 years) still achieve a nice return even if stocks are expensive. For most people with a long-term horizon, the ideal strategy is still to continuously buy low-cost ETF funds and rely on the fact that we as a society are gradually moving somewhere technologically and economically. At least that is exactly how I continue with this strategy.