STOCK PRICES ARE INCREASING... SO?
Based on Bloomberg data, the S&P 500 has been trading for over 20 times the trailing price-to-earnings. The market last touched that breakthrough in 2009 in the wake of financial crisis and recession.
Stock prices are escalating as of present. Should we care about it?
Previous pricing trend is not an indicator of a stock’s future performance. Historically valuation multiples are. Also, it does not make sense to compare the value of bonds and stocks. The latter is cheaper than bonds. Special monetary policy makes the former expensive. Not to mention the policy’s stern outlook for nominal and real global growth. Corporate earnings may likely reflect a lower multiple.
Higher figures give a clear warning. Let us be specific on this one: past prices do not reflect future results. In some instances, though, value does matter in long periods. The level of the P/E at the beginning of this year indicated almost 6% of the variation in the returns of the succeeding year, based on the annual price returns over the last six decades do not account dividends.
Historically speaking there is a difference in returns following periods when the P/E was higher and lower than the average of 16.5. The median return was nearly 5% in the years after reaching above average valuations. The average return then was higher than 11% in years when the aforementioned index kicked off the year on the low side.
Returns have slumped in the coming year in periods when the trailing P/E closed the preceding year above 20. The median annual return then was almost 1%. Besides that fact, the bottom quartile of returns was -11%. All of these occurred when stock prices skyrocketed.
Stock prices are going up. Should we care about it? Sure, the market is overvalued but it does not call for a celebration. We must not panic, either. It just so happened that the bonds are trailing the worse portion of trading. The best option as of the moment is to keep the trading plan in check, monitor the movements, and think ahead.
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