Equity valuation: Where’s the bottom?
The endless series of new index lows has repeatedly confounded investors who see equities as having become cheap again. The rally at the end of last year has raised hopes once more that valuations might have found a bottom. However, for some leading strategists, what looks like cheap today may not be cheap enough.
Despite the last week of November offering the best week for stocks for about 75 years, the bear market rally has struggled to gain traction.
"Sure equities are cheap compared with where they were a year ago when people were already saying that they were cheap enough to withstand a recession but equities are a lot cheaper now," says Albert Edwards, chief investment strategist at SG CIB. "The problem, however, especially for the US, is that we had a valuation bubble that peaked in 2000 and which has been structurally de-rating since. Cyclically adjusted P/E ratios in the US are still 40% too expensive in our view."
"The rally between 1982 and 2000 was P/E-driven rather than earnings or dividends-driven. Lower inflation led to lower bond yields, which, in turn, drove equity multiples substantially higher. P/E expansion accounted for well over half of the capital gain of equities during these years. In that environment, people didn’t care about dividends because they earned their risk premium from capital gains. Now that the P/E expansion is over, however, the market will expect to earn its risk premium through dividends. If companies don’t have the cash for that, prices will continue to fall, the way they did in Japan."