US stock markets could be looking for sustainability after February's rampant rally powered by Magnificent Seven earnings. CFRA Research Chief Investment Strategist Sam Stovall

"Right now the S&P 500 (^GSPC) technology sector is trading at a 56% premium to its average P/E on forward 12-month earnings over the last 25 years," Stovall says. "On a relative basis, it's at a 25% premium to the S&P 500 itself, even though it is primarily the driver of the S&P 500. So, a lot of other sectors are in 20% premium areas like communication services..."

Stovall also comments on tech valuations, AI-exposed stocks, and his expectations for Thursday's PCE print.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

JOSH LIPTON: Markets facing volatility this week ahead of a crucial inflation report that will guide expectations for interest rate cuts. For more on what to take away from the latest market moves, we want to welcome in now Sam Stovall, CFRA Research chief investment strategist. Sam, it is always good to see you and have you on the show.

And I want to start here, Sam, on Bitcoin. And not to get your take on Bitcoin, Sam, I know you're a stock guy. But, you know, I look at Bitcoin, Sam, and I see it surging past $60,000. You know, it's up more than 40% already this year. And it's not just Bitcoin, Sam.

When I look at some of these AI-related names, and just the wild moves we see in names like, you know, SoundHound, Supermicro, I'm wondering, Sam, as a long time market pro, when you look at these moves, what do you take away from that, Sam? Does it tell you anything about risk appetite right now?

SAM STOVALL: Well, Josh, good to talk to you again. I think it is certainly a representation of the risk appetite, where investors are very willing to be chasing these stocks with the expectation that at least those that have earnings are going to be showing improved earnings as we move into 2024 and into 2025. Bitcoin is sort of interesting because it has no earnings. It pays no dividend.

It's not used in an industrial fashion. So, you really can't say that it's like gold. I also would find it hard to wear. Of course, you'd probably be-- it could be the emperor's clothes if you did. So, basically, I would tend to say you want to be focusing on those areas where you actually have value and can, therefore, monitor whether you're overpaying or having a good bargain.

JULIE HYMAN: Well, Sam, hey, it's Julie here. You know, I definitely have been noticing, you know, all of these big moves that we're seeing in companies that actually do stuff. You know, from an Nvidia to a SoundHound. Viking Therapeutics yesterday was an example.

We're going to talk about that more later in the show. You know, a lot of speculative activity, but it's not from nothing, right? There is some stuff, some there there, so to speak. So, what does this tell you about sustainability in this market?

SAM STOVALL: Well, there is some there there, as you were saying. There are earnings. But I think that what might be happening, at least in the near term, is that these expectations are getting ahead of the reality. I mean, right now the S&P 500 technology sector is trading at a 56% premium to its average PE on forward 12-month earnings over the last 25 years.

On a relative basis, it's at a 25% premium to the S&P 500 itself, even though it is primarily the driver of the S&P 500. So, a lot of other sectors are in 20% premium areas like communication services. Also looking at healthcare and industrials, two groups that have continuously notched new all-time highs.

JOSH LIPTON: And, Sam, you're talking about valuations for different sectors. I'm curious, though, to also get your take on how you're thinking about valuation for just the broad market. Because I hear some very smart strategists, Sam, and they say, listen, things to them-- and granted, valuation, always in the eye of the beholder, as you like to say.

But they'll say it looks rich. It looks lofty. I'll say other strategists, though, Sam, who say that's just the wrong way to think about it. You can't compare this market to the market 10 years ago or 20 years ago because different economy, different companies. How do you think about it, Sam?

SAM STOVALL: I think history definitely has a place in valuations because how do you know if it's undervalued if you have nothing to compare it with? How do you know it's overvalued if you have nothing to compare it with? And that starts to sound like the rationale that I heard back in the late 1990s when the S&P was trading at 60 times forward earnings.

Right now the tech sector is bumping up against 30 times forward 12-month earnings, and that has been a high water mark, a resistance level for quite some time. So, we'll have to see whether that breaks above. But right now, I think what we're finding is that things are getting a bit rich and I would rather see earnings start to improve in order to justify some of these valuations. And actually, a digestion of gains or correction probably wouldn't be bad because I do have high hopes for the market for all of 2024.

JULIE HYMAN: And so, all the same, 30 is not 60, right, in terms of that price to forward earnings. And so, would you use the B word, the bubble word, to describe what we've been seeing?

SAM STOVALL: Well, not yet necessarily. I think there is certainly enthusiasm for the AI stocks, Nvidia in particular, mainly because the growth potential does seem so wide. We're in the embryonic phase of this AI revolution.

So, yes, I think there is an awful lot of optimism or unsubstantiated optimism just based on what the future could hold. But I would then just say to investors, you know, don't buy blindly. Or if you do, make sure you have a long holding period because it probably could take some time, if we do go through a correction, to get back to break even.

JOSH LIPTON: Sam, I'll get you out of here on this big important data point tomorrow. PCE, Jay Powell's preferred inflation gauge, what are you expecting to hear there, Sam? And how important is that for the market?

SAM STOVALL: Well, I'm expecting to hear a higher number as compared with last month. So, month-over-month, both the headline and core are likely to be backing up showing a bit hotter readings. Year-on-year, however, my belief is that they will continue to show a downward trend.

But comparing the PCE with the market's results following the CPI and PPI, I say it's like dropping a ping pong ball on a table. The first bounce is the greatest and then subsequent bounces are more muted. So, with so much time for investors to, in a sense, worry about what the PCE might hold, I think we'll have less of a response than we did to the prior reports.

JULIE HYMAN: That's a nice visual, as well as audio image, for me, the ping pong ball. Sam, it's always great to catch up with you. Thanks a lot. Appreciate it.

SAM STOVALL: Yup. My pleasure, Julie.