Ben Laidler, global markets strategist at the investment and trading platform eToro, talks to us about the increase in valuation risks in the US. “The "exceptionalism" of US GDP growth and concerns about interest rates Higher long-term highs are putting upward pressure on yields, along with the return of the “term premium” from broader uncertainties, from fiscal sustainability to election results,” he explains.
Valuation risks in the US are increasing
HEAD WINDS:
Valuation risks in the US are rising again. The S&P500 price/earnings ratio is now well above long-term averages and rising 10-year bond yields have widened the gap with our fair value P/E to 40% (see chart). Stocks have become less sensitive to rising yields over the past year, but there will still be an inflection point.
The "exceptionalism" of US GDP growth and concerns about higher long-term interest rates are putting upward pressure on yields, along with the return of the term premium to greater uncertainties, from fiscal sustainability to election results.
This makes the Q1 earnings season recovery crucial and supports our rotation into cheaper “safe” assets.
FAIR VALUE:
We use 10-year US bond yields, corporate profitability, and long-term GDP growth estimates to estimate a "fair value" P/E for the S&P 500 (SPY). It has a good long-term track record, but has broken down recently.
The current 13x is low and a record 40% below the S&P 500 consensus 21x. This is the largest gap in a decade and reflects market overload, with the Magnificent Seven concentrated at highs and investors' expectations of better earnings growth and, potentially, economic growth in the future.
A 0.5% increase in the 10-year bond yield reduces our P/E by 7%. A return to the long-term GDP outlook of a decade ago (2.6% versus 1.8%) raises it by 10%.
DOUBLE FOCUS:
It also reminds us of the relative risk and reward of markets. Technology is the largest sector in the US, already very profitable, with already high valuations.
It is well supported, but the increases are now occurring in other sectors. We see a growing rotation towards cheaper sectors, such as finance and real estate, and towards regions, such as Europe and emerging markets. They are the ones with the most room for valuations to rise.
They are also "insurance" against further pressure on valuations if bond yields rise, and have the dual advantage of providing the largest rebound in earnings relative to our baseline scenario of a soft landing for the economy and lower interest rates.
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Source: Territorioblockchain.com
