Record highs in the S&P 500, driven by mega-cap tech stocks, have sparked concerns about market overvaluation. However, a ProShares strategist suggests the risk may be less than feared due to significantly lower leverage compared to two decades ago.
While current market valuations appear stretched, with a price-to-earnings ratio around 25x compared to the typical 18x-20x, Simeon Hyman of ProShares Advisors argues that reduced leverage plays a crucial role in mitigating risk. He points out that the S&P 500 net debt-to-EBITDA ratio has plummeted from 5x to 1x over the past 20 years. This indicates a healthier financial foundation for companies, lessening the vulnerability to market downturns.
Hyman emphasizes that current corporate profitability stems from strong asset returns rather than debt-fueled growth, particularly within the technology sector. This underlying financial strength supports the notion that seemingly exuberant market valuations might be justified. His analysis suggests that “at least some of the exuberance that drove expanding multiples may, in fact, be rational.”
Chart showing S&P 500 debt to EBITDA
Despite this perspective, prominent investors like David Einhorn have voiced concerns about the market reaching historically high valuations. While stopping short of declaring a bubble, Einhorn cautioned against the current market environment. Analysts generally advise maintaining exposure to the US market, but calls for a potential correction have intensified, particularly if the “Magnificent Seven” tech stocks falter.
Matt Powers, managing partner at Powers Advisory Group, highlights the concentrated risk in these mega-cap tech companies. He suggests that an earnings miss in 2025 could trigger a broader market downturn, emphasizing the importance of diversification for investors. Even without a significant correction, weaker returns are possible if the momentum of the Magnificent Seven stalls.
Chart showing S&P 500 price to earnings ratio
While Wall Street anticipates continued S&P 500 growth, with an average year-end 2025 price target around 6,539, the potential for lower returns underscores the need for a cautious approach. The debate surrounding market overvaluation continues, but the significantly reduced leverage offers a counterpoint to widespread anxieties. Investors should carefully consider both the risks and potential opportunities in this complex market landscape.
