Are US stocks now cheaper again?

  • Significant improvement in the valuation situation of the S&P 500 following the correction, but investors should keep this in mind as a first „warning shot“
  • A PER of 15.5 is calculated for the S&P 500. In historical terms, this valuation would not be too dear. Nevertheless, the valuations of certain companies continue to spin out of control.
  • We currently see higher price potential for the European markets.

 The equity markets have fallen significantly this week for the first time in a long time. Price developments were characterised by overshooting in 2017, especially in the USA. These cases of overshooting have now been considerably reduced. For the S&P 500, a current price-earnings ratio of 15.5 based on the expected profits for 2019 (and uptuned by the US tax reform) is calculated. In historical terms, this valuation would not be too dear.

Nevertheless, the valuation of some companies continue to spin out of control. This applies not only to technology and biotech companies but also to many defensive companies. Examples here are the pharma group Johnson & Johnson; although analyst estimates do not expect profits to rise much this year, the valuation based on the price-turnover ratio of five points is as high as it was during the dotcom bubble. „Alternative“ valuation indicators, such as the Shiller PER or the ratio of market capitalisation to gross domestic product, also signal overvaluation at market level.

What led to this overshooting? – Put simply, the share prices of major US companies have „only“ risen stronger than corporate profits. And this occurred despite the fact that companies bought back huge volumes of own shares in past years, therefore actually stimulating the „earnings per share“. Part of the price upswing is attributable to the expansionary monetary policy of the Fed including the QE programme, which drove out many investors from large sections of the bond market and let to a run on stocks.

However, it should not be forgotten that US key interest rates are quoting at an extremely low level by historical comparison and that there is little likelihood of any dramatic change occurring in the foreseeable future.

Ideally, preference should be given to an investment in stocks over an investment in bonds if the earnings yield (the inverse of the PER) is higher than the yield on long-dated sovereign bonds until final maturity. Historically, the difference between the earnings yield on stocks and the yield on US treasuries with ten-year maturity lies at around 2.7%. Most recently, the corresponding US yield quoted at 2.8%; this means that the equity market reaches a fair earnings yield at 5.5% or a PER of 18.2. The current PER of around 16 lies below this level.

Even if key interest rates were to increase in the years ahead, the situation will not change to any significant degree. However, we expect US key interest rates to only reach 2% over a twelve month horizon and capital market returns to also rise hardly at all. In other words: The US equity market is dear in relation to its own history, but we do not see any valuation premium versus the bond market. For the European markets, on the other hand, we currently see higher price potential.

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