S&P 500 index hits record highs repeatedly, institutions: investors should consider looking for value stocks

According to the Wisdom Financial APP, the S&P 500 index continues to hit new highs, sparking discussions in the market about the so-called "melt up" phenomenon. In this situation, investors may consider looking for value stocks, especially those who are concerned about the current stock market's high valuations.

Contrary to a stock market crash, a melt up typically refers to a series of factors working together, such as the Federal Reserve cutting interest rates in the backdrop of a still strong economy, pushing the stock market to unsustainable highs.

Yardeni Research defines a melt up in a recent report as "when the expected price-to-earnings (P/E) ratio of the S&P 500 rises much faster than the expected earnings per share (EPS) growth of the S&P 500." In other words, a melt up may occur when stock prices become significantly more expensive relative to corporate profits. (Expected P/E ratio refers to the ratio of stock price to expected earnings over the next 12 months.)

For investors in the U.S. stock market, it has indeed been a bountiful time recently. The S&P 500 index has already hit 47 new highs this year, with the most recent one occurring last Friday. Despite the index falling about 0.4% on Monday, it has risen over 23% year-to-date.

So, does all this indicate the arrival of a melt up?

"It's hard to say, but we may be getting closer to this scenario," Yardeni wrote in a report last Sunday. "The stock market seems to continue to ignore geopolitical risks, especially in the Middle East, and also overlooks domestic political risks in the U.S., especially with the upcoming elections."

Yardeni pointed out that since the start of this bull market cycle in October 2022, the expected P/E ratio of the S&P 500 has surged from 15.3 times to 21.9 times, an increase of over 40%. Meanwhile, the expected earnings per share for the next year has only grown by 14%.

Yardeni is not the only one concerned about the high P/E ratio of the S&P 500. Jefferies' quantitative strategy team noted in a report last Sunday that while the previous market rally was mainly driven by the "Big Seven" tech stocks, this year, the other 493 stocks in the S&P 500 index have seen a larger proportion of gains.

As a result, the P/E ratio of these 493 stocks has risen from around 17 times since July 2023 (the last Fed rate hike) to over 19 times now.

Jefferies believes that stock prices have already fully priced in expectations of future Fed rate cuts, so future market gains will need to come from corporate earnings growth. Yardeni remains cautious about this and has set a target price of 5800 points for the S&P 500 in 2024, essentially flat with the current level, and predicts a modest growth of about 8.6% by the end of next year.

The firm suggests that the best strategy for investors is to look for stocks that are still in the value range. However, this is not easy as many traditional value sectors, such as utilities and industrials, appear overpriced compared to historical levels.

Instead, Jefferies has used a proprietary screening tool to identify stocks that have strong financial fundamentals but lagging stock price performance. Their top picks include Ralph Lauren (RL.US), Morgan Stanley (MS.US), Amazon (AMZN.US), and Google's parent company Alphabet (GOOG.US, GOOGL.US) In the current high valuation stock market environment, seeking out these value stocks may be a wise choice for investors to deal with market fluctuations and the risk of a liquidity-driven rally