According to a recent study conducted by Bank of America Merrill Lynch, fund managers believe that stocks are the most overvalued they have been in almost 20 years. But, are they right? Yes, the S&P 500 stock index has enjoyed an extended bull run, but have equities reached their peak or are current valuations justified?
Pierre Trottier, a portfolio manager at Industrial Alliance
Investment Management Inc., believes that, although it is not cheap, the market is not overvalued either. Since December 30th of last year, the S&P 500 is trading at 16.9 times forward earnings, which is just one point of a multiple above the 25 year average of 15.9.
“If we look at the market peak of March 2000, the forward price earnings multiple at that time was at 27.2 times,” says Trottier. “That was a case of overvaluation, and the dividend yield was 1.1% and the 10 year treasury yield 6.2%. Now, the dividend yield is at 2.2% and the 10 year treasury is at 2.5%. The yield is close to the ten year treasury, which gives further traction for equities.”
Based on projected earnings-per-share growth – 10% in 2017 and 12% in 2018 – the market shows no sign of being overvalued. Valuations are nowhere near the highs of March 2000 and there is certainly space for the bull run to keep on going.
“Also, looking at the S&P 500, there is no bubble in any sector,” Trottier says. “In 2007, for example, there was a bubble in financials, but now there is no bubble anywhere, so that is more encouraging. The dividend yield, and other metrics that measure valuations, also show there is no over valuation in the market right now. Right now, I would recommend using an active management strategy to find companies cheaper than the market.”
Trottier has noticed a general warming to equities recently with significant funds entering the space from the retail, client side. It’s a trend he expects to continue for the next couple of quarters as yields on bonds also continue to rise.
“Some people think that if yields are going up then equities will fall but, since 1975, data shows that as yields go up there is no price earning contraction for the S&P 500 multiple,” Trottier says. “It is more the opposite that happens – when the yield goes up on the treasuries, usually there is a price earning multiple extension associated with that. We are at 2.4% right now, so there’s room for bond yields to go up higher.”
“Of course, a course a correction can happen any time, there have been 50 corrections in the past 60 years, but to end the current bull market we would need a recession in the U.S. or a shock to the economy, which I don’t foresee.”
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