With the exception of emerging market equities, stocks are having
an extraordinary year, particularly after accounting for the fact
that global economic growth has disappointed this year. Given the
magnitude of the gains, investors are increasingly concerned that
global stocks are
once again getting overvalued
, if not in an outright bubble. I last addressed this topic in
mid-August. At the time,
view was that valuations were not yet an impediment to further
. Since then, global equities have advanced roughly 7% to 8%. Yet
despite the additional gains, I still don't believe it's accurate
to describe stocks as in a bubble. Consider these four facts:
Valuations are no longer cheap, but they are still a long
way from the peaks seen in previous cycles.
U.S. stocks trade for around 2.5x book value and for 16.5x
trailing earnings. Looking at the last three major market peaks -
1987, 2000 and 2007 -
price-to-earnings (P/E) ratios
were respectively 23, 30 and 17.5. The price-to-book ratio,
meanwhile, peaked at close to 5 in 2000 and 3 in 2007.
As I discussed in August, valuations look more reasonable
outside of the United States.
, international stocks are 30% to 40% cheaper than U.S.
On a relative basis, the earnings yield on stocks still
compares favorably with the fixed income alternative.
Compared to bonds, which have been bid up through central bank
intervention, stocks still look cheap.
Despite strong in-flows year to date, many investors
are still underweight equities.
Unfortunately, this is not the whole story. Traditional valuation
metrics miss three nuances:
The speed of the rally.
While valuations are not at extremes, stocks rarely record the
types of gains witnessed since the 2009 lows. Over the past 40
years, there have only been two other instances in which stocks
have rallied this far this fast: the run-up to the 1987 crash and
the late 1990s, as the figure below shows.
The dependence on margins.
One reason that stocks look reasonable is that, thanks to low
interest rates and slow wage growth, margins are at historic
highs. If rates or wages rise, margins will compress, driving
earnings lower. This will make stocks look more expensive (this is
why stocks look more expensive based on
Shiller P/E ratio
implicitly assumes some mean reversion in
The extent to which low rates are propping up
. Low rates don't just support margins, they also support
multiples. With bonds offering no competition, stock valuations are
higher than they would typically be
In summary, today's valuations are largely dependent upon the
continuation of an unusual set of circumstances. Where does this
leave investors? Probably in the same position they were in back in
August. Stocks can still move higher, assuming rates stay low and
margins high. I'm
…. for now.
Russ Koesterich, CFA,
is the Chief Investment Strategist for BlackRock and iShares
Chief Global Investment Strategist. He is
a regular contributor to
and you can find more of his posts