A lower-cost way to play the S&P 500's run to 5,000

Published Thu, Feb 8 202411:04 AM EST

The S & P 500 once again closed at a new all-time high, achingly close to 5,000 for those enamored of nice round numbers. Perhaps there's a specially embroidered hat in one of those NYSE booths waiting to be donned when the hammer drops above 5,000? Astonishing as it may sound, if this year delivered another blockbuster as 2023 did, a conversation about the S & P 500 cresting 6,000 might get started around Christmas. Is that even possible? What got us here, and what would have to follow to get us there? .SPX 1Y mountain S & P 500, 1-year Is there an option trade we can use if we're not sure? We'll discuss. The Bear Case: Isn't this, as esteemed investor Jeremy Grantham has coined it, a "super bubble"? The chorus of those who share a bearish view on equities is loud and getting louder. What is it that so many bears are concerned about? Investors concerned that we are in a bubble cite many of the following factors: High Valuations: Some asset prices, whether in stock markets, real estate, or other investment vehicles, are at levels that are hard to justify with traditional valuation methods. High price-to-earnings ratios in some of the largest stocks, such as Nvidia which is trading at greater than 63 times earnings or Tesla at 95 times earnings are cited as examples. The ratio of the median home price to median income is at record highs, even though interest rates are not at record lows. Commercial real estate is faltering, and a speculative bubble in another large economy - the China real estate market - is clearly faltering. Speculative Investments: A surge in speculative trading, often driven by retail investors or fueled by new, easy-to-use trading platforms, can indicate that market participants are engaging in riskier behavior based on the expectation of continued price increases, rather than underlying value or fundamentals. We've certainly seen plenty of speculative trading in everything from cryptocurrencies to meme stocks to Rolexes. Low Interest Rates: Extended periods of low interest rates, as have been seen in many economies around the world following the 2008 financial crisis and during the COVID-19 pandemic, can lead to increased borrowing and investing in riskier assets, inflating their prices. Given this dynamic, it stands to reason that if interest rates were kept artificially low for an extended period, then asset prices would be pushed artificially high. Technological Disruptions: The rapid rise of new technologies and sectors tend to attract investors to the idea even if the reality doesn't match the hype. Such was the case in the internet frenzy of the late 90's into early 2000, and such was the case with some cryptocurrencies, NFTs, electric vehicles companies, and solar stocks. More recently, AI stocks are the rage. Surely these technologies will indeed change the world, but that doesn't necessarily mean that these areas aren't overbought. Economic Conditions: Arguably this is the biggest source of frustration for the market's naysayers. Many have predicted bleaker economic conditions since well before the beginning of 2023, however headline GDP and employment data has confounded the bears. A deeper dive into the economic data presents meaningful areas of concern (many of the employment figures over the past year have been revised downward). The economy is propped up by remarkably high deficit spending, and rising interest rates only serve to worsen government budgets. I do NOT agree with the Paul Krugmans of the world who describe this economy as better than 'Goldilocks" because, as he puts it, you get a best of both; a hot economy and cool inflation. However, these facts remain true. The U.S. economy is consumer driven. Consumers are spending. Headline unemployment is, for the moment at least, low. Historical Precedents: Looking back at past market bubbles that burst, leading to significant financial losses (e.g., the dot-com bubble of the late 1990s, the 2008 housing market crash), investors may draw parallels with current market conditions, prompting fears of a similar outcome. The Bull Case: How has this translated to corporate earnings? Well 60% of the S & P 500 stocks have reported earnings so far, and greater than 70% of the index by market cap. Collectively these companies reported $384.6 Billion in earnings, beating Street estimates by almost $28 Billion, or 7.8%. So far that looks like 4.6% year-over-year EPS growth. That growth rate, annualized, would get us to $234 for 2024. If that's true, then the S & P is currently trading at 21.4 times full-year earnings. The historical average is just under 20. Also if that growth rate is maintained for the rest of the year, that is a lower growth rate than usual. The bears believe earnings will grow more slowly than usual, and may even fall, but… S & P earnings have historically grown much faster than the economy. Seven percent is a better approximation of the compound annual growth rate. If S & P earnings grow closer to their historical average, then $240ish (let's stick to round numbers) might be a more accurate estimate. $240 a shares multiplied by 20 = $4,800 in the S & P. So in that context 5,000 is a little rich, but not much. While many squawk about "high" rates, the 10 year treasury yield is only about 30 basis points higher than the 30 year average, and those 30 years aren't really representative when one considers it includes a decade+ of artificially low rates. Right now the S & P corporate trailing earnings yield (this inverse of the P/E ratio) is 4.2% vs a 10 year treasury yield of 4.1%. For those who might immediately suggest that stocks, due to their riskier nature, should have a higher yield than Treasuries, they do, because, as history shows those earnings grow handsomely over time. It took me 900+ words to explain the bull case and the bear case. So now the big question…who's right? The trade I don't know, and it doesn't matter. I suspect the recent large layoffs are an early tell that there's more ailing our economy than the headline numbers suggest, but I could have pointed to a lot of warning signs over the last 1,000 S & P points and what a loss that would have been. I think we'll get some answers soon, so why not have it both ways? Don't buy the S & P 500 stocks, buy a call option. The VIX Index , a measure of 30 day volatility in the S & P 500, is below 13, cheaper than usual. A SPY March 28th month-end $500 strike call costs $8.40 or less than 1.7% of the underlying. Bought March $500 SPY call for $8.40 Do you think we'll know by then whether we'll breach $5,000 or go lower? I do. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL'S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. 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