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February 3, 2022

Kelly Bogdanova
Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.

The S&P 500 is attempting to find its footing following a 12 percent pullback on an intraday basis in Jan.

Market participants seem like they are beginning to accept a more accelerated Fed rate hike cycle and the uncertainties that go along with it.

Importantly, the overall positive trends during the ongoing Q4 2021 corporate earnings season hint that 2022 consensus earnings estimates are not at much risk of retreating—at least during this reporting period.

Since the market’s lowest intraday level on Jan. 24, performance has clawed back, and the S&P 500 is now down “only” 6.1 percent year to date.

As we examine underneath the surface of the pullback, with a particular focus on which stocks have been the worst performers (growth stocks in the Consumer Discretionary sector and technology-related industries) and which stocks have held up the best (value stocks, especially Energy, followed by Financials, Consumer Staples, and Utilities), we notice a positive development. The market’s most acute valuation problem has become less troublesome. In other words, the reduction in the market’s valuation has primarily come from the right places—the most expensive stocks. We view this as healthy.

Releasing some pressure

The S&P 500’s overall valuation has been lofty since soon after the index began to recover from the COVID-19 low in the spring of 2020. But the price-to-earnings (P/E) ratio actually drifted a bit lower in 2021 as consensus earnings growth estimates and actual earnings growth far outstripped the price return of the index. The valuation dipped further during the January 2022 pullback.

The market’s valuation drifted down in 2021 and dipped further during the recent pullback

S&P 500 price-to-earnings ratio based on 12-month forward consensus earnings estimates

S&P 500 price-to-earnings ratio based on 12-month forward consensus earnings estimates

The line chart shows the S&P 500's price-to-earnings ratio drifted down in 2021 from 22.6x to 21.4x at year end as earnings growth outpaced the price advance of the index. The valuation declined further in January 2022 to 19.8x as the market pulled back.

Source - RBC Wealth Management, Bloomberg estimates; data through 2/3/22

The market is still rather pricey at 19.8x the consensus earnings estimate for the next 12 months. This is well above the 16.2x long-term average since 1990 and is higher than the 18.6x average that has prevailed during the ultralow interest rate period of the past five years. (This is one of the reasons we think investors should double-check equity allocations in portfolios to ensure there is adequate representation of less expensive markets outside of the U.S.)

When it comes to the U.S. market, however, not all parts of it are equally expensive—some stocks are much richer than others. The biggest source of the valuation problem lies within the large-capitalization segment represented by the S&P 500 and Russell 1000. Roughly 20 percent of the stocks in these indexes have very rich valuations, with most residing in the growth category.

The good news is that the highest valuation stocks retreated the most—by far—during the recent pullback. In the S&P 500, low P/E stocks pulled back only two percent while high P/E stocks corrected by 13.6 percent in January. Even among technology stocks, there was a wide performance gap. In the “TECH+” category—technology-related stocks in the Information Technology sector and other sectors—low P/E stocks pulled back 5.4 percent, while high P/E stocks corrected by 19 percent.

The selloff was most pronounced in high P/E stocks

Price return in January 2022 of low and high valuation stocks based on price-to-earnings ratios (P/E)

Price return in January 2022 of low and high valuation stocks based on price-to-earnings ratios (P/E)

The bar chart shows during the January 2022 selloff in the U.S. market, stocks with high price-to-earnings (P/E) ratios sold off much more than stocks with low P/E ratios. Among S&P 500 stocks, the low P/E category retreated 2.0% in January, while the high P/E category sold off 13.6%. Among technology-related stocks, the low P/E category sold off 5.4%, while the high P/E category sold off 19.0%.


Low P/E

High P/E

*TECH+ category represents technology-related stocks in the Information Technology and other sectors of the S&P 500

Source - National research correspondent, Refinitiv, FactSet

Furthermore, RBC Capital Markets, LLC’s Head of U.S. Equity Strategy Lori Calvasina points out that the valuation of the Russell 1000’s most expensive stocks compared to the least expensive stocks pulled back notably during the recent correction, and is now near the pre-pandemic level—another positive sign.

We doubt the highest P/E stocks are fully out of the woods. There could be more valuation compression as the market continues to work through lingering uncertainties about Fed policy, inflation, and economic and earnings growth.

While valuation isn’t the most important factor when determining equity positioning in portfolios—the market’s P/E ratio can stay lofty or cheap for long periods of time, longer than one might think is rational—the fact that air has come out of the U.S. market’s most expensive stocks is a healthy development. We think it’s supportive of our overall recommendation to hold a moderately Overweight equity position in portfolios. There are still likely to be bumps in the road this year, but we expect equity markets to ultimately regain their composure, opening the way to fresh new highs in the major indexes.

The valuation of the most expensive stocks compared to the least expensive stocks pulled back notably in January 2022 (top line), and is now near the pre-pandemic level

U.S. large-cap median P/E quintile comparison. Quintile 1 (the most expensive category) vs. the lower Quintiles 2-5 (Quintile 5 is the least expensive category)*

U.S. large-cap median P/E quintile comparison.

Pre-pandemic

Q1 vs. Q2

Q1 vs. Q3

Q1 vs. Q4

Q1 vs. Q5

The line chart shows the relative valuations of segments of the U.S. equity market from January 1990 through January 2022, represented by price-to-earnings ratios in the large-cap Russell 1000 Index. The index is divided into quintiles, and the top quintile is compared to each of the others, producing four relative valuation lines. All four lines begin at low levels in 1990 and trend higher over the decade before spiking in 2000, then fall meaningfully through 2003. The lines are roughly steady until 2015 when they begin to climb again, accelerating in 2018 and reaching rather high levels in 2020 (though still below their 2000 peaks). The lines fall at the beginning of 2021 but rise again at the end of that year. Most recently, during the January 2022 equity market pullback, they fall somewhat. The key point of the chart is that in January 2022, the difference between the valuation of the most expensive stocks in the market (quintile 1) and the least expensive (quintile 5) fell to near the level it was just before the COVID-19 pandemic began.

*Data based on 2023 consensus earnings per share forecasts (excluding negative EPS)

Source - RBC U.S. Equity Strategy, S&P Capital IQ/ClariFi, CIQ Estimates; Bloomberg, Large Cap Universe is the Russell 1000 Index, Quintiles are ranked based on FY2 P/E ex Neg EPS, Median FY2 P/E is used to represent every quintile; data as of late Jan 2022.


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Kelly Bogdanova

Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.