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While mega-cap tech stocks have led the S&P 500 to record highs, the market now hovers at valuations some consider to be extremely over-priced. That might be a pointless worry, a ProShares Advisors strategist said.
"It comes down to the following surprise: there is a lot less leverage in the stock market than there was just 20 years ago," Simeon Hyman told Bloomberg TV on Friday.
In a note published last week, the global investment strategist acknowledged that stocks were expensive. Typically, a stock's trailing price-to-earnings multiple would trade between 18x to 20x amid current Treasury yield levels — instead, the ratio hovers at around 25X.
Other indicators further highlight that market valuations have reached historical extremes.
Despite these conditions, Hyman outlined that low market debt levels can diminish risks associated with an elevated P/E multiple. Compared to 20 years ago, the S&P 500 net debt/EBITDA has fallen from 5x to 1x.
The note also found that today's equities are raking in high returns from assets, and not from debt-fueled growth. This indicates underlying profitability, Hyman said.
"The significant decline in leverage of the S&P 500 and the robustness of today's profitability (due in part to the technology sector) suggests that at least some of the exuberance that drove expanding multiples may, in fact, be rational," Hyman wrote.
Still, overstretched market conditions have increasingly unsettled investors this year, catching the attention of Wall Street heavy-hitters such as David Einhorn. In October, the billionaire hedge fund manager warned that traders were fueling the most expensive market in decades.
That's not to say the market is in a bubble, he wrote, and analysts largely agree that investors should stay exposed to the US market. However, calls for a correction have amplified this month, especially if the top "Magnificent Seven" tech stocks surrender recent gains.
Given the heavy concentration in these mega-cap names, a 2025 earnings miss could "turn the market," Matt Powers, managing partner at Powers Advisory Group, told CNBC. Therefore, investors should emphasize diversification next year, even if tech growth remains strong.
Even without a correction, traders may need to brace for weaker returns if Mag 7 momentum turns flat. Generally, Wall Street institutions expect the S&P 500 to keep climbing, with an average year-end price target of about 6,539.
