It’s encouraging to see some signs of reasoning by the administration when it comes to economic policy. But we need real, tangible evidence. The tone could completely change by today, and at least some damage has already been done.
The market is still overvalued in comparison to prior market lows, and against the backdrop of higher rates. Not to mention earnings estimates needing to be revised lower.
If we look at the stock market selloffs of 15% or more since the cyclical bull market broke out in 2013, the average price-to-earnings ratios bottomed between 14.7 and 15.3x.
We only got down to 18.2 and 20.4 for the forward and trailing PEs, respectively, which is 25% to 33% ABOVE the average of the PEs during the prior market lows.
But what if we don’t get a recession? Well, three of those four market selloffs weren’t accompanied by a recession either.
And look at the difference in interest rates. The average is almost double the average of the prior bear market lows.
The equity risk premium (ERP) is simply taking the earnings yield and subtracting it from the 10-year rate. The higher the risk premium, the more favorable the stocks are. In the prior 4 market lows, ERP averaged 4.44%, compared to the April 7th low, which came in at 1.51%.
So essentially, valuations are about 30% above the average of the prior market lows, while rates are almost double. Not exactly very appealing, even if we get some positive resolutions on trade.
Yes, the forward PE got to 25x during the COVID recovery as the market began pricing in an earnings recovery early. But rates were below 1% at that time, so the bar was set so low that there really weren’t any alternatives to stocks.
This is not a prediction, nor am I trying to scaremonger. I’m trying to be rational here. I’m still bullish for the long term, but I think the current fundamentals aren’t favorable enough to try to chase this thing. .