📈Overnight, the US markets reached yet another record high, driven by continued tech enthusiasm, optimism on the US-Iran war and the earnings season
❓With the S&P500 Index trading at 26x P/E (based on Bloomberg statistics), not far from the 20-year high of 33.3x in the fourth quarter of 2020, one can’t help but wonder, are current valuations of US shares sustainable?
✍Macquarie’s Sales and Trading desk (S&T) discusses this topic in a note published this morning
Read on for important disclaimer:
This communication has been prepared by Sales and Trading (S&T) Personnel at Macquarie and is not a product of the Macquarie Research Department. For important disclosures relating to this communication, please see: www.macquarie.com/salesandtradingdisclaimer
Main points
This is the single most important question facing investors. A collapse of US equity bubble will have implications on almost all assets globally, and in many cases, more severe than in the US itself. Where do markets currently stand? On almost all long-term valuation criteria SPX is expensive.
1. On the widest canvass, value of US equities is now at approximately 2.5x GDP and, as the Fed highlights, market equity value of US corporates is more than 3x GDP. Both ratios are at the highest ever level vs historical average of around 100%.
2. Tobin Q (relationship between corporate market value and replacement cost of its assets) is also at the historical high of around 2x, with the greatest ever deviation from the norm (~0.8x), bypassing the dot.com high of 1.5x.
3. Schiller's cyclically adjusted PER (CAPE) stands at around 42x, double the average since 1950 (approximately 20x) and around 3x over the long-term (e.g. since 1881). Only in the lead-up to dot.com was CAPE higher.
4. While neither CAPE nor Tobin Q had ever delivered trading signals, both have a solid track record over the longer term, including marking beginning and end of secular bull and bear markets.
5. As for longevity of bull/bear phases, today's bull market commenced in early 2009, and has already delivered real gains of more than 500%, approaching upper limits of prior bull phases over the last 150 years.
6. Concentration of returns is now the highest in modern era, with top ten SPX stocks accounting for more than 40% of market capitalization and while individual names change, exceptionally high concentration of returns has persisted for years, with limited (if any) signs of broadening. Any of the above should make investors nervous. However, there are also significant differences with prior eras.
1. For the first time in history, we reside in a world of excess capital (around 5x-10x GDP). Anything that is in abundance can never be priced, explaining lack of clearances, inequalities and the need for regulatory oversight. But, it also cushions assets and economies while turbocharging technologies.
2. This mix (i.e. disruptive Information Age and abundant capital or what we describe as the Fujiwara Effect) is accelerating business cycles, facilitating a faster than hitherto creation and destruction of business models, with studies indicating 4x to 5x pace of prior eras.
3. In their turn, accelerating cycles generate powerful zero marginal cost waves that suddenly derate prior winners (e.g. games, software) while creating ground for new winners (e.g. chips, LLMs). These new winners will also eventually derate, creating new bubbles in sectors that require zero marginal costs to prosper (e.g. robotics, automation, biotech, 3D printing, metaverse). This implies that at an index level, investors might not see much change, despite violent churning underneath.
4. The above does not mean that the Fed is powerless to cause a recession but to argue that policymakers no longer have the same control over rates, markets or economies, and would never have strong reasons to deflate bubbles, as these would be deflating and reflating of their own accord. Stay invested but diversify to avoid getting caught in deflating bubbles of prior winners.
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