The stock markets are very expensive – a problem?

We are in a time of extremes. We will have the worst recession in the post-war period, accompanied by the fastest stock market correction. This was followed by the strictest quarantine measures, as well as the fastest and most extensive aid packages from central banks and governments. Now we can observe the fastest recovery movement on the markets. After the market lost around 40% of its capitalization in less than 30 days, the DAX and S&P 500 have gained over 30% in the last 40 days.

Although prices are trading below their old highs, valuations are shooting through the roof as profits and profit expectations are falling sharply. Since the high in February, earnings estimates for 2020 have already been reduced by more than 20% and this trend should continue. The S&P 500 is trading at a P/E ratio of 19.2 – the highest since 2002. The DAX P/E ratio is lower at 13.3, but valuation has risen by 50% in recent weeks.

Certainly governments and central banks are supporting the financial markets with the aid measures that have been decided upon, and of course the stock markets as well. An undistorted view of economic expectations is currently offered by the oil price, which has not recovered after its crash. On the other hand, we have been experiencing stock markets boosted by low interest rates and high liquidity for several years now. The necessary dose has been increasing as the stimulus measures are subject to diminishing marginal utility, but the long upward trend has continued.

The ultimate dose from governments and central banks now came at the beginning of the corona crisis. This will be hard to beat. At the same time, companies are in the midst of an economic storm that will leave behind profit and dividend cuts. This increases the risk of pronounced setbacks, partly because of the high valuation. However, there should not be a sell-off and a long downward trend on the stock markets. In the event of such a development, the stability of the financial markets would be endangered in the long term and no relevant party has any interest in this.

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