US equity valuations are a source of extreme consternation for many investors currently.
There are two main issues.
First, stocks re-rated at the beginning of 2023 as yields retreated in a broad, cross-asset rally aided and abetted by ongoing dollar weakness. That rally was snuffed out last month by a hawkish repricing across the US rates complex, accompanied by a rebound for the dollar. Despite the pullback, US shares haven’t de-rated in a meaningful way, or at least not to the extent you’d expect given what, at Tuesday’s extremes, was a near 80bps increase in market-implied Fed terminal rate pricing versus early February levels.
Second, there are two components to a P/E ratio, and some top-down strategists on Wall Street are concerned that the “other” component — i.e., profits — is at risk from margin headwinds and limited capacity to push the pricing power envelope further than it was already pushed.
No one argues that US shares are a bargain, but just how expensive are they relative to other assets? The answer vis-à-vis bonds (and particularly USD “cash,” which now yields nearly 5%) is very expensive. But they’re also expensive relative to pretty much everything else.
On a forward multiple, the S&P trades in the 67%ile using a 10-year lookback. That figure is 15%ile, 50%ile, 21%ile and 46%ile for European, Asian, Japanese and emerging market equities, respectively.
Obviously, US and German government bonds are the cheapest they’ve been in recent memory, and valuations for spreads are middling (at most) both for USD and euro credit, although as ever, you could argue US junk doesn’t accurately reflect recession risk.
The table below from Goldman (current as of the beginning of March) shows you yields and compares them to historical levels — so, it’s the mirror image of the figures mentioned above.
To reiterate the obvious, bonds and credit boast the highest yields many younger investors have ever witnessed.
Bottom line: Making the case for US stocks at the current juncture is quite difficult. That probably helps to explain why US equity funds have seen some $40 billion in outflows in 2023.
Updated data on weekly fund flows, including for US equity ETFs and mutual funds, was due Thursday.
