By Philip Lawlor, head of Global Investment Research
Amid the relentless ascent in global equity valuations since March, none has soared as high as those of US stocks.
As shown below, the Russell 1000 multiple is up more than nine points from its March low, far outdistancing the average five-point gain for its developed peers. At a forward PE of 22.9×, the Russell 1000 is near a 15-year peak and has further widened an already huge premium to those of other developed markets, which have converged around 15-16×.
Regional 12-month forward price/earnings ratio (×)
Source: FTSE Russell / Refinitiv. Data as of July 15, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
As the chart below illustrates, multiple expansion has been the major driver of the risk rally that began in late March. It has occurred despite double-digit declines in forward EPS forecasts for most markets over the same period. Given the still-elevated uncertainties in the economic and profit outlooks, the key question now is whether this PE expansion can continue.
Total return decomposition since March 23, 2020 low (% change)
Source: FTSE Russell / Refinitiv. Data as of July 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Cyclically adjusted PEs (or CAPE) show an even wider rift between the US and the rest of the world. At 24×, the Russell 1000 also stands at a 15-year high (barring its February 2020 peak of 25.9×) and a large premium to developed peers, which continue to languish well below the peaks reached before the Global Financial Crisis.
Regional cyclically adjusted price/earnings (CAPE) ratios (×)
Source: FTSE Russell / Refinitiv. Data as of July 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
While CAPE is an unreliable timing tool, there is an historically strong positive correlation between US CAPE and 10-year-forward annualized returns, as the chart below illustrates. Today’s comparatively lofty US CAPE suggests returns are likely to be lower over the next decade than during the previous 10 years. This, coupled with the stretched levels of US valuations more broadly, holds important implications for investors and asset allocators.
US CAPEs (×) versus 10-year-forward annualized real returns (%)
Source: FTSE Russell / Refinitiv. Data as of July 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Photo Credit: herval via Flickr Creative Commons
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