Karen Ward, a chief market strategist for JPMorgan Asset Management has taken to the Financial Times to warn investors that current S&P 500 valuations suggest returns of zero-percent for the next ten years. She writes:
How worried should we be about stock market valuations? In my day-to-day conversations with clients, it seems that investors are unsure.
On the one hand, they can see the US economy is bouncing back quickly, vaccines are being rolled out more rapidly in continental Europe and both governments and central banks are in no rush to rein in stimulus. For the global economy, the good times look set to roll.
At the same time, stock valuations in many regions are troubling. A key measure is the cyclically adjusted price-to-earnings ratio made famous by Robert Shiller. For US stocks, this is at a level that has only been seen at one other point in its 140-year history: the tech boom. And that was followed by a spectacular bust.
My preferred valuation measure uses one-year ahead forward earnings. With the S&P price index at over 22 times, this measure of earnings is still uncomfortably above the long-term average.
While valuations have little predictive power for near-term returns, the relationship with long-term returns is very strong. If the past three decades serve as a guide, then the current valuation points to an average annual return for the S&P over the next 10 years of . . . zero.
Is this time different? I’ve heard two arguments for why high valuations will not hinder long-term returns. One I find convincing. The other I do not.
The argument I am not persuaded by is that valuations are permanently supported by low interest rates. This cannot be right over the long term. Either policymakers have navigated the pandemic so well that equilibrium economic and earnings growth, and interest rates will revert to prior levels. Or there will be lasting scars. In which case, we will be stuck in a low nominal growth, earnings and interest rate environment.
It cannot be right that we will come out of the crisis with sustainably higher earnings growth and sustainably lower bond yields. Central banks may be distorting bond prices with asset purchases and other monetary tricks. But, at some point, in the face of rising growth and inflation, bondholders will eventually tire of continually negative real returns and sell those bonds, pushing yields higher.
The alternative argument, which is more compelling, is that valuations will not be problematic because the recovery in nominal activity will be more spectacular than analysts are predicting. Given S&P 500 company earnings are expected to rise 30 per cent this year and end the year more than 10 per cent above the pre-Covid-19 level, this might seem like a bold statement.
But one must not underestimate the potential for a boom in the second half of the year. US households accumulated “excess savings” of 8 per cent of gross domestic product last year. They are now in the process of receiving fiscal stimulus amounting to another 5 per cent of GDP.
Read more here.