Swelling US stock valuations leave some investors uneasy

Date: 07 December 2020

Author(s): David Carnevali and Eric Platt

Source: Financial Times

 

By one measure, US stocks have been getting so expensive that only the dotcom boom saw higher valuations.

 

Ever since Joe Biden won the election as US president, coupled with the materialization of the Covid-19 vaccine breakthroughs, the approx. $41 trillion market has skyrocketed, elevating benchmark stocks indices to unprecedented heights.

 

However, some investors are feeling apprehensive about the extent in that stock prices have diverged from corporate earnings. According to Deutsche Bank, the cyclically adjusted price-to-earnings ratio (also known as the CAPE ratio) of the S&P 500 that was developed by economist Robert Shiller rose to 33.4 at the start of December. Which places it above the level of September 1929—the eve of the Great Depression—and nearly double that of its historic average of 17.

 

It was only during the technology bubble entering the millennium in December 1999 did the ratio rocket as high as 44.2, exceeding current levels.

 

“There are great expectations built into this market,” CIBC Private Wealth Management CIO, David Donabedian said. “We are in the seventh inning of Federal Reserve -supported equity markets,” he said, adding that the CAPE ratio is a warning call for the longer term although the short-term outlook remains positive.

 

Following the amplified efforts rolled out by the Federal Reserve and central banks around the globe to minimize the financial and economic fallout from the pandemic, valuations of US stocks have risen. In March, the Fed cut rates close to zero, and in April it pledged to buy government bonds in unlimited amounts, pushing yields on long-term debt down to historic lows.

 

“Low interest rates and easing monetary policies are the single biggest factors for equity outperformance,” said Mr Donabedian.

 

Technology stocks—particularly the biggest tech companies including Apple, Microsoft, Amazon, Google-owner Alphabet and Facebook who now account for 22 per cent of the S&P 500 compared to just under 17 per cent at the end of last year—have grown 36 per cent this year, outperforming the broader market’s 14 per cent gain.

 

Investors will not be taken by surprise by above average readings of the CAPE ratio as it has been pointed to by pessimistic money managers for a decade as one factor why stocks have come to be unbound from corporate earnings. Deutsche Bank noted that since 1991, outside of a period during the financial crisis, the CAPE ratio has been above its long-term average. Notwithstanding that, the S&P 500 has achieved a total return of beyond 1,700 per cent in the years since.

 

Keyword : sterlinghousetrust.com, Sterling House Trust, SHT