Earlier this week, the S&P 500 reached an all-time closing high, and U.S. equities aren’t the only ones hovering around record highs. On a global basis, stocks have advanced more than 40% since the summer of 2012.
Given the extraordinary performance of most equity markets and the percentage of gains driven by expanding multiples, it’s not surprising that many investors are wondering whether the bull market has run its course and a June swoon is on the horizon.
My take: While there are few absolute bargains left anywhere in the equity market and stocks are no longer cheap at the aggregate level, equities at the broad level aren’t so stretched as to suggest that valuation alone is likely to end the bull market.
As I write in my latest Market Perspectives paper, “Has the Bull Market Run Its Course,” although a number of valuation metrics today suggest lower returns over the next five years than enjoyed over the previous five, global valuations are neither indicative of a market top nor at a point that would suggest aggressively lowering equity allocations.
U.S. large cap valuations, for instance, as measured by the price-to-earnings ratio of the S&P 500 index, are above their long-term average, but not obscenely so.
In addition, the overall macro environment – one of low inflation, low interest rates and accelerating growth– is a favourable one for stocks and is supportive of modestly higher valuations. Historically, investors have paid more for a dollar of earnings when inflation is lower. Nor is the prospect of rising rates a significant threat, at least not at these levels. When yields are below 4.5%, as they are today and should be through at least early next year, multiples actually tend to rise along with rates.
It is true that other metrics paint a more negative picture. The Shiller P/E ratio, a cyclically adjusted price-to-earnings (CAPE) ratio, suggests U.S. stock valuations are unambiguously expensive. However, today’s levels are not yet in the nosebleed territory that characterized the 2000 Internet bubble stocks and aren’t yet at a level that suggests negative returns over the long term.