The stock market is edging toward extremes of Great Depression and dot-com eras

Image of a stock trader at the New York Stock Exchange.

Equities look historically high relative to government bonds.Johannes Eiselle/Getty Images

  • Stock-market valuations, by one measure, have hit highs surpassed only a few times in history.

  • Equities look historically high relative to government bonds, according to PIMCO and GAM Asset Management.

  • The market’s upbeat expectations on future corporate earnings may “face disappointment,” says PIMCO.

After a rally that defied high interest rates and recession calls, stock valuations are now edging toward levels seen before some of the greatest market meltdowns in history – by one measure at least.

A time-tested way of assessing whether equities are fairly valued is by comparing them with government bonds, considered one of the safest forms of investment.

And by that metric, stocks are looking historically expensive, according to experts from PIMCO and GAM Asset Management.

A key measure of the richness of stocks relative to debt is the so-called equity risk premium — or the extra return on shares over Treasury bonds.

The metric has plunged this year, indicating stretched stock valuations, toward levels seen during the Great Depression of the 1930s and the dot-com bubble of the late 1990s.

“Delving deeper into historical data, we find that in the past century there have been only a handful of instances when US equities have been more expensive relative to bonds – such as during the Great Depression and the dot-com crash,” PIMCO portfolio managers Erin Browne, Geraldine Sundstrom, and Emmanuel Sharef write in a recent research note.

“History suggests equities likely won’t stay this expensive relative to bonds.”

The historically low equity risk premium is a deterrent to investing in stocks, according to Julian Howard of Switzerland’s GAM Asset Management. It means stocks are offering investors little incentive to choose them over risk-free assets such as government debt – and that may turn away potential buyers.

“The equity risk premium is very, very narrow. Now, in fact, it is actually almost negative,” Howard said in comments on the GAM website.

“And that is a major concern because what it is saying is that actually you don’t need to invest in equities in the short to medium term, because if you invest in the six-month Treasury bill, which is giving you 5.5% completely free of risk, then that’s actually a risk-reward that is completely unbeatable,” he added.

US stocks are on track for their best month in a year amid expectations the Federal Reserve may have reached the end of its interest-rate increases at a time when the economy remains resilient and inflation has moderated.

The S&P 500 is up 7.4% in November, taking its year-to-date gains to 17.3%, amid optimism that corporate earnings will remain buoyant in the coming quarters.

However, PIMCO cautions against that outlook.

“We feel that robust forward earnings expectations might face disappointment in a slowing economy, which, coupled with elevated valuations in substantial parts of the markets, warrants a cautious neutral stance on equities, favoring quality and relative value opportunities,” Browne, Sundstrom, and Sharef wrote.

Read the original article on Business Insider

Source link

About The Author

Scroll to Top