While current conventional wisdom says that stocks have become expensive and are setting the stage for a meaningful correction, Morgan Stanley’s Global Investment Committee maintains that US stocks are “fairly priced at worst and downright cheap [considering] low interest rates,” and stocks outside the US are even cheaper.
Explaining the committee’s position, a note on the company site refers to the consensus bottom-up 12-month forward earnings estimate divided by the Moody’s Baa yield, a particular valuation metric they focus on because unlike many traditional measures, it takes both earnings and interest rates into account.
“Right now that sets our ‘fair value’ measure for the S&P 500 today at 2,833,” said Mike Wilson, chief investment officer for wealth management at Morgan Stanley. The S&P 500 opened at 2,286.01 on Jan. 30.
Wilson also noted that the measure effectively identified overvaluation in the 1990s that left investors badly burnt, and explained the 2008-2009 stock market collapse.
Another metric supporting the committee’s contrarian view was the cyclically adjusted price earnings ratio (CAPE), otherwise known as the Shiller P/E. By dividing prices by 10-year average historical earnings rather than a single point estimate, the CAPE provides an accurate long-term view of the broader stock market.
While the CAPE is approaching higher levels, “[w]e are still well below the levels reached in the late 1990s,” Wilson said, adding that the current numbers suggest lower, but not negative returns in the next 10 years.
“With interest rates so low, that means stocks still look relatively attractive,” he said.
WP's discretionary/portfolio manager of the year 2016 speaks out
Trump bulls wearing blinders, says expert