US Equity Valuations

Important Ratios

Equity Risk Premium

By comparing the current real cost of debt and equity for companies, and subtracting the current real interest rate.

• A fall in the ERP on this scale is unusual. Such a fall in 12 months “has only occurred seven times prior to now since 1983 and usually coincides with a large monetary event or an equity market shock/bubble.” Lenner CS.
• In the 12 months to the end of August 2023, the S&P 500 managed a price return of 14%. Of that, increasing price/earnings multiples accounted for 12.4 percentage points, according to a decomposition by Patrick Palfrey of Credit Suisse AG. Earnings themselves accounted for 1.4 percentage points. So valuations have boomed.
• For valuations like this to make sense, investors must be assuming that bond yields are going to tank, which can only happen if inflation is not only beaten but totally trashed.

https://www.bloomberg.com/opinion/articles/2023-09-11/equity-risk-premium-s-guide-to-the-galaxy

Shiller P/Es or “CAPEs"

Shiller P/Es or “CAPEs" (for Cyclically Adjusted Price/Earnings multiples): compare stocks to average earnings in real terms over the previous 10 years

Tobin’s Q ratio: compares stocks to the total replacement value of their underlying assets.

• Even if tech stocks, obviously generating excitement at present, are excluded, these measures suggest that stocks are historically expensive, at valuations comparable to the eve of the Great Crash in 1929 and of the GFC in 2007:
• The all-time record for the Shiller P/E in 2000 was followed by a terrible decade; the 50-year low it touched in the early 1980s was the signal for a fantastic bull market. It has good predictive power in a longer time frame.
• A high Shiller P/E functions like a low implicit equity risk premium; it only makes sense if you think inflation will be tame, and hence bond yields can come down.

https://www.bloomberg.com/opinion/articles/2023-09-11/equity-risk-premium-s-guide-to-the-galaxy

https://www.multpl.com/shiller-pe

Ratio SP500 relative to Corporate Bonds

• In August this year, the S&P 500 climbed to levels last seen during the peak of dot-com boom, relative to an index that tracks the US corporate bond market, according to data from global analytics platform Koyfin. The gauge is still holding near those highs, despite the recent pullback in equities.

https://finance.yahoo.com/news/last-time-us-stocks-were-211718680.html

Ratio SP500 Yield relative to 10 year treasury yield

https://twitter.com/Barchart/status/1713177839082627342/photo/1

Husman estimates that equities will lag bonds by more in coming 10-12 years than at any point in history aside from the period following the 2000 bubble peak.

https://twitter.com/hussmanjp/status/1709248732141609154/photo/1

https://twitter.com/KobeissiLetter/status/1711430546520191025/photo/1

Ratio SP500 Yield relative to short term Treasuries

https://twitter.com/GameofTrades_/status/1713959236311597141

https://twitter.com/dailychartbook/status/1715332534546968880/photo/1

The Buffet Indicator

The Buffett Indicator is the ratio of the total United States stock market cap to GDP.

The most common used measurement of the aggregate value of the US stock market is the Wilshire 5000.

• The current Buffett Indicator value of 167% is 1.2 standard deviations above the trend line, indicating the market is Overvalued.

https://www.currentmarketvaluation.com/models/buffett-indicator.php

https://www.currentmarketvaluation.com/models/buffett-indicator.php

Analyst Opinions

Valuations Concerning:

• Morgan Stanley (March 2023) : In fact, over the past two decades, this risk premium has sat between 300 and 350 basis points; currently it’s at 167. This isn’t much different from what an investor might expect to earn from investment-grade credit, which generally is considered less risky than stocks. Investors can perhaps afford to look past inflated valuations when economic fundamentals are hitting bottom, monetary policy is loosening and market expectations are low, we are not in such environment.
• Liz Young, SoFi Head of Investment Strategy (Jul 18, 2023): Stock prices have continued rising as yields have risen, those divergences do not last forever, and something has to happen to close that gap eventually. She thinks this relationship still matters, but that the economy may be different, less interest rate sensitive, and the AI enthusiasm has made the market not care about rates for now.
• Jason Trennert, Strategas Research Partners chairman and CEO (Jul 27 2023): Even looking at the most optimistic estimates for earnings next year equity market doesn't look cheap. But markets can remain overbought longer than they stay oversold.Most value now is from sectors that have not participated in the rally so far.
• Aswath Damodaran, professor of finance at NYU Stern School of Business (Aug 11 2023): Markets are overreach currently, but don't think will get to the 2022 lows. However, he admits markets tend to overshoot or undershoot in both directions. ERP has value in 5-10 years, but not way to know when the move will happen.
• Jeffrey Gundlach (Sep 19 2023, 28:30): Difficult to have love for stocks when the ERP is at 17 year lows by a lot. The price action this year is mostly PE expansion, earnings haven't done much, and estimates for 2024 are high, markets not pricing for a recession, and he thinks the economy will not be as robust in 2024. He only likes long-term treasuries as short-term trade in anticipation of a recession, he thinks investment grade is not cheap due to spreads being low still, High-yield bonds you can find some opportunities but he is not interested, he likes mostly credit in the structured market due to better spreads.
• Bill Gross, Pimco co-founder (Oct 4 2023): Equity investors would need to justify entering the market without a risk premium by relying on potential increases in productivity and a stronger economy, he is not in this camp, and thinks PE ratios are coming down to increase the equity risk premium. He thinks inflation will settle higher than 2%, and 5% on 10 year treasury is still not great value due to the fiscal issues.
• Jeremy Grantham (October 5 2023): We are currently in the deflating part of the bubble from 2021, we will enter a deep recession in the near term, and we are entering a new era of higher yields. Yields at current levels, it would be mathematically reasonable to think the US market as whole could fall by 50%, he contends. There’s trouble ahead if the “magnificent seven,” the few companies that have been carrying the index this year, lose any part of their magic.
• Larry Fink, BlackRock chairman and CEO (Oct 13, 2023, 4:00): Pension fund, and corporate funds will start selling more equities and buying more bonds. Not happening yet, but will happen. There are opportunities to earn 7-15% on credit, with a high probability of success, that's where a lot of money is moving.
• John Hussman (Oct 17 2023): Market valuations stand at one of the three great bubble extremes in US history, rivaling the peaks of 1929 and 2000. Those two previous periods of reckless speculation ended disastrously, and the current bubble is likely to unwind in similar fashion. That's not a forecast, but it certainly is a historically-consistent estimate of the potential downside risk created by more than a decade of Fed-induced yield-seeking speculation. Hussman noted the S&P 500 is priced today for a negative return over the next 10 to 12 years. The gap in expected returns between stocks and bonds is now among "the worst levels in history," and the gauge's total return is poised to lag Treasury bond returns by about 6.5% a year for the next decade.
• Jim Bianco (Oct 26 2023): Despite thinking the economy will reaccelate from here, this meand inflation will be higer, and rates too..He does not think we are in a new bull market, majority of stocks are finding sifficulty to have upside momentum, so we will enter an eviroment where good stock picking will be the only way investing will work.

Valuations not concerning:

• Bill Ackman ( Sep 28, 2023, 8:00): Despite thinking that yields will increase even more and that inflation will be structurally higher, he thinks there is still value in companies that can have pricing power in this new environment.