Stocktake: Are US stocks cheap?

US stock valuations have cratered. Are equities cheap?

They're certainly much cheaper than they were. Even as the S&P 500 fell 20 per cent, US earnings estimates kept rising following another strong earnings season. Consequently, notes Schwab's Liz Ann Sonders, the decline in the index's forward price/earnings ratio is approaching 30 per cent, near the low reached during March 2020's pandemic bear market.

FactSet data shows the S&P 500 now trades on 16.6 times forward earnings. For the first time since April 2020, it is trading below its five- and 10-year valuation averages (18.6 and 16.9, respectively).

But it’s not all good news, FactSet adding that valuations remain above their 15-, 20- and 25-year averages. Furthermore, valuations remain “well above” the lowest price/earnings ratio of the last nine years (March 2020’s low of 13.1).

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Additionally, cautions Morgan Stanley, stocks still look overvalued when compared to prior periods of high inflation. Over the last 70 years, US price-earning ratios have averaged about 12 when inflation has been running as high as it is today.

DataTrek Research is also sceptical. Firstly, estimated earnings may be too high. Secondly, it’s “hard to argue” that valuations should be roughly the same as their 10-year average, given inflation and interest rates are higher now.

“Valuation is just a number,” says DataTrek, “and the context around that number matters far more in assessing whether we’re truly ‘cheap’.”