Stocktake: Even bulls concerned by US valuations

Valuations and the recent market melt-up will limit any 2021 advance

Citigroup strategists expect stocks to tread water this year. Photograph: iStock

Citigroup strategists expect stocks to tread water this year. Photograph: iStock

 

Jeremy Grantham’s belief that the US market is in bubble territory is not shared by most observers. However, you don’t have to be a bear to be concerned about US valuations.

In his 2021 outlook, JPMorgan’s Michael Cembalest makes the case for continued market gains, pointing to an earnings rebound, technical factors and zero interest rates. However, valuations and the recent market melt-up will limit any 2021 advance.

Looking at nine valuation metrics, Cembalest found the median metric indicated the US market is more expensive than it has been 93 per cent of the time. Three metrics indicated “maximum expensiveness” (100 percentile); a fourth, the forward price/earnings ratio, was in the 97th percentile. Stocks look cheap relative to bonds, but expensive on every other metric.

Sentiment, too, is concerning, “with most readings in the 90th percentile of optimism or higher”.

Citigroup strategists are preoccupied by the same concerns. Citi expects stocks to tread water in 2021, noting the MSCI World Index is trading at 20 times estimated earnings – much higher than the long-term median of 15. The US is the most expensive major market, it adds, with the UK the cheapest. Meanwhile, Citi’s Panic/Euphoria model suggests sentiment is euphoric right now.

The US now trades on 23 times forward earnings and 30 times trailing earnings, notes S&P Dow Jones Indices’ Howard Silverblatt.

Even if we get record earnings, “justifying that much of a premium is unprecedented”. Including dividends, the S&P 500 gained 18.4 per cent in 2020 and 31.5 per cent in 2019. It has, as Silverblatt puts it, “been a heck of a run”.

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