The year 2023 defied expectations for Bay Street and Wall Street. Despite stubbornly high inflation and decades-high interest rates, the U.S. stock market closed out the year with one of its best performances. The S&P 500 advanced 24%, its longest winning streak since 2004, while the Nasdaq soared more than 43%, its highest annual gain since 2020. Meanwhile, the TSX staged a late-year rally, ending 2023 up 8.12%.
How Are U.S. and Canadian Stocks Doing?
For many stocks, the biggest gains came over the last two months of the year. In early November, the U.S. Federal Reserve suggested its interest rate hikes were done for this economic cycle and then in December, the Fed said it would begin cutting rates in 2024. That’s just the kind of fuel investors need to become overly optimistic.
The late-year momentum carried into 2024 with the Dow Jones hitting a new record high on February 2, the S&P reached a new milestone on February 7, and the Nasdaq hit its highest intra-day level ever on February 8. The TSX has held onto its gains since November and is just 5% below its April 2022 highs.
Strong economic data has provided bulls with more than enough confidence that the U.S. economy will benefit from interest rate cuts and a soft economic landing.
The Canadian economy isn’t doing nearly as well as the U.S. economy, with the Bank of Canada saying interest rate cuts are coming, but not imminent. While Canadian inflation cooled to 3.4% in December, shelter costs (rent, mortgage costs) are running a lot hotter. To get inflation down to 2%, analysts think the Canadian economy needs to experience a short, shallow recession.
Are U.S. Stocks Overvalued?
Despite investor bullishness, investors should remain a little cautious. The Nasdaq, S&P 500, and Dow may be at record levels, but valuations are in the stratosphere.
According to the Case Schiller CAPE/PE Ratio, the S&P 500 is overvalued by around 101%. The index is currently sitting at 33.63, the historical average is 16. That means that for every $1.00 of earnings a company generates, investors are willing to pay $33.63. The index has only been higher twice: in 2000 and 2021. That also means stock valuations are higher than they were back in 1929, 1987, and 2007.
The big moves over the last few months have some strategists warning that the S&P 500 could struggle to make much headway over the rest of the first half of the year. Why? Large cap tech stocks have posted impressive profits, but even there, investors afraid to miss out are paying way too much for that growth.
Amazon’s trailing Price-to-Earnings (P/E) ratio is 58.33 while NVIDIA’s is a whopping 90.00. That’s well above the S&P 500’s current level of 22.29 and historical median average of 17.88.
Valuations are not nearly as high on the TSX, with a trailing P/E of 26.31, a little higher than the historical average of 22.00. Analysts still expect the TSX to hit record levels later this year, however.
The last time Canadian stocks traded at such a large discount to the S&P 500 was in 2000, with Canadian stocks outperforming over the next decade. Relative to the S&P 500, Canadian stocks are trading with a much better entry point.
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The S&P 500, Nasdaq, and Dow are all trading at record levels. While profits are solid, bullish investors have lifted valuations to near-historic levels too. The TSX is expected to hit new records in 2024 but the valuations of domestic stocks are much lower. Which Canadian stocks should investors pay attention to when inflation data comes in? Ask the trading professionals at Learn-To-Trade.com.
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