Stock valuations have climbed to levels reached just before Wall Street’s late 2018 plunge, leaving the market at risk of shocks such as the sell-off this week as global trade tensions mounted.
“Whenever you get up to these levels, you just become more vulnerable,” said Matt Maley, equity strategist with Miller Tabak. “We know that valuations can stay high for extended periods of time, but it does make the market vulnerable to new negative developments and that is kind of what we are seeing this week.”
As of Thursday’s close, the S&P 500 was about 2.6 per cent below its all-time high close, which in turn reduced the forward P/E multiple on the S&P 500 to about 16.7 times, still well above the historic average of 15.1 times. On Friday, the S&P 500 fell modestly in early trading. The yield on the benchmark 10-year U.S. Treasury note sits at 2.45 per cent after eclipsing 3.2 per cent in November, making bonds look less competitive as an investment versus equities. Stocks are typically valued through by estimating their future cash flows, which are more valuable at lower rates.
Jonathan Golub, chief U.S. equity strategist at Credit Suisse, issued a report this week, titled “The Case for Much Higher Valuations”. It contended that by comparing prices to company cash flows, stocks are actually trading at a 20-per-cent discount to their historic averages. That imbalance leads some market watchers to say that any significant leg higher for stocks rests on the earnings picture improving, as opposed to valuations going even higher.
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