Many investors are looking for an answer to the question of what's going on in US stock markets. A pandemic, an economic crisis, a prolonged lockdown, and with all this, the major stock indexes are still near all-time highs. So are stocks currently expensive?
We'll take a look at US stock indices: S&P 500 and Nasdaq 100. But in addition to just judging whether something is expensive or cheap, it's worth remembering the context and environment. A bottle of water in the desert may have a different price than a bottle of water in a city market.
The indicators that are supposed to tell investors whether a stock is expensive and overvalued or cheap and undervalued are influenced by many factors. In addition to their very design, such as capitalization to GDP or price to earnings, the aforementioned environment also seems to be important. The very construction of these ratios must also be understood by the investor. Looking at current price-to-earnings ratios, one does indeed get the impression that stocks are expensive. The P/E for the S&P 500 is 41, for the Nasdaq 100 it is 40. These are indeed high levels, but one must remember that the stock market is discounting the future. So a more accurate look would be to calculate current price to earnings projections, or forward P/E. For example, the P/E for the S&P 500 a year ago was at 25. The forward P/E indicates a level of 26. This means that the market expects companies to grow earnings faster in the future than the stock price, which has already grown under that expected higher earnings.
Nevertheless, someone could get the impression that the indicator at the level of 25 times earnings is still quite high, as the average over the decades is about 15. And here the key may be the mentioned market environment. Before central banks started experimenting with non-standard monetary policy tools, capital could flow between stocks and bonds depending on their yields, that is, depending on monetary policy and interest rates. The current policy of zero interest rates around the world results in capital, of which there are more and more, having few alternatives and being able to constantly flow into the stock market. This is lifting average valuations to higher levels and it appears that this may be a permanent trend over the next few years. So higher valuations may be very likely. Thus, prices may continue to climb until interest rate hikes become real, which would balance the stock-bond market. However, that may not happen until closer to 2023.
So in trying to answer the question of whether US stocks are expensive - yes, according to current indicators they might be. They're priced above average according to forward indicators, but by the market environment they don't seem to look very expensive, they're just at the level elevated by zero interest rates average.
Daniel Kostecki, Chief Analyst Conotoxia Ltd.
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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