Investors should be wary of “frothy” valuations

Advisor picks out price earnings valuations as something investors should be wary of in 2018, adding that multiple contraction is possible at some point

Investors should be wary of “frothy” valuations

Investors should be mindful of current price earnings valuations. That’s the view of Glen Rankin, of Rankin Financial Planning, who says PE valuations are “getting rather frothy” and that it will pay to stay alert in a rising-rate environment.

As the 2018 market whirs into action, Rankin said valuations are above the term averages and a pullback is possible, while the differing tax approaches of the US and Canada governments will not help the economy this side of the border.

He said: “I do think unless we have significant earnings growth, some of these [PE valuations] may be pulled back a little bit, so we might see some PE contract. I think it is very possible we could see some price earnings multiple contraction at some point.

“I do believe that we are in a different environment with government bond yields and treasury bill yields at their low, so higher price earnings multiples might be warranted in the current environment. However, I think we are starting to test the boundaries of that. I do think, based on the headwind of taxation and volatile commodities and things like that, that Canada is likely to see an economic … not necessarily recession, but the growth levels will definitely slow down significantly over the next year.

“When you add in the US tax cuts versus our heavy tax and spend policy we have here in Canada, I do believe that Canada will be relatively less attractive barring some other unforeseen events.”

In offering advice to investors for 2018, Rankin added that just because central banks are likely to tighten their belts, investors should not stop diversifying.

He said: “Don’t get too carried away with valuations and anticipate that we are in a bit of a rising-rate environment based on the economic growth that we’ve seen.

“Central banks are going to be managing inflation. However, just because that is occurring, it doesn’t mean you shouldn’t be diversified. I think you should be diversified and rebalance you portfolio back to your asset allocation.”

He added: “We just need to be mindful to stick to a long-term strategy and not be too caught up in short-term movements. I believe that the valuations are in a range where you have to be cautious. So the question is really, are we in a new environment where because of low Treasury bill yields, low long-term government bond yields, the higher priced earnings multiples are warranted?

“What do those price earnings multiples look like compared to those of, say, bonds if you were doing an equivalent comparison? Stocks are expensive, bonds are relatively more expensive, but that being said, during times of turmoil, people will tend to flee to those bonds.

“We saw that back during the financial crisis – there was a little bit of flight out of equities and people will look for safe havens. I do believe it is wise to be diversified and rebalanced back to your target, take profits off the table as your asset mix drifts and go back to your long-term asset allocations strategy.”

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