Despite higher rates, U.S. stocks have scored several record highs in recent weeks.
Stocks have been posting new records despite investor concerns about slowing U.S. corporate profit growth, persistent sluggishness in the economy and Greek bailout negotiations – to name just a few of the headwinds facing equities today. Adding to the anxiety is the fact that many investors are reasonably worried over the impact of the first Federal Reserve (Fed) tightening in nearly a decade.
Even Fed Chair Janet Yellen couldn’t help noticing in May that stock prices had become “quite high,” leading many to speculate that the U.S. central bank thought stocks had become overvalued.
However, there are several reasons why I believe we’re not yet at the peak.
Market highs aren’t the same as market tops, and stocks reach new highs fairly often. The S&P 500 has “celebrated” a new high on average 13 times per year, or 5% of all trading days, since 1928, as the chart below shows.
Note: Shading represents a new high in the S&P 500. Past performance is no guarantee of future results. A logarithmic scale is a nonlinear scale used when there is a large range of quantities.
Source: Bloomberg, BlackRock Investment Institute, as of 5/19/15.
And this statistic may understate the true frequency of market highs, since it includes the 25-year period after the 1929 crash when the S&P 500 failed to reach a new high. In other words, the market highs aren’t actually very newsworthy, given that they happen so often.
Valuations can go higher. With the exception of the 2007 market peak, most of the bull markets of the past 25 years witnessed a peak valuation on the S&P 500 of roughly 20x to 22x 12-month trailing earnings, higher than the S&P 500’s 17.5x valuation today. To be sure, not surprisingly, market peaks in the higher inflation, higher rate environment of the late 1960s to the mid-1980s tended to occur at a lower valuation, not far from where we are today. However, we’re in a different scenario, given the low-inflation, low-rate economic environment we expect for the foreseeable future.