VALUATIONS: Nearly all the returns made in US stocks this year has come from rebounding valuations. This re-rating has again taken valuations above long-term averages (17.4x P/E) and made the US the world’s priciest market. Higher bond yields are now depressing the ‘present value of future cash flows’. This has opened up a rarely seen 30% valuation chasm to our ‘fair value’ sanity check (see chart). This is a cause for concern but not panic. As we think 1) Bond yields should ease. 2) Earnings are set to recover. 3) And cheaper valuations are available under the surface. Plus, history may be a poorer guide, given the changed nature of US stocks.
SOLUTIONS: We see three offsets to the current high valuation angst. 1) US 10-year bond yields should fall, with both 2% real bond yields and 4% NOWCast GDP growth expectations near historic peak levels. 2). Second quarter earnings season is the trough, with earnings -5%, and forecast to be growing double digit by January next year. Both US and overseas earnings growth forecasts are rising. 3) The Value vs Growth valuation gap has widened to a near record 50%, giving options to those looking for some valuation ‘insurance’. This is similar globally, with only India having a similar 19x forward P/E valuation as the US among all major stock markets.
CONTEXT: Long term historic US valuation comparisons may also be a poorer guide. High profit margin tech-related stocks are now a much bigger part (40%+) of markets. At the same time as long-term inflation (2%) and GDP expectations (1.85%) are still low. This combination supports higher valuations for growth centric assets like stocks in general and particularly tech. As well as for a wider valuation spread between Growth and Value sectors. It’s also a support.
All data, figures & charts are valid as of 14/08/2023.