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NEW YORK, July 30 (Reuters) – The rebound in corporate earnings and the recent decline in bond yields are helping to moderate U.S. equity valuations, strengthening the case for stock ownership even as markets are close to bottom lines. records and that economic growth is expected to slow.
The benchmark S&P 500 has climbed more than 17% so far this year, galloping higher despite concerns about spike in inflation and an expected drop in economic growth.
At the same time, however, stock valuations have fallen slightly since the start of the year. The S&P 500 price-to-earnings (P / E) ratio, a commonly used measure of market valuation, stands at 21.4 times earnings estimates for the next 12 months, according to Refinitiv Datastream. That’s still well above its historic average of 15.4, but below January’s 22.7 level.
Meanwhile, a rally in treasury markets that has seen the yield on 10-year treasury bills fall by 50 basis points since late March as bond prices soared has also helped to increase the appeal. shares as an investment.
“I think the stock market is always the place to be,” said Peter Tuz, president of Chase Investment Counsel in Charlottesville, Virginia. “Even though valuations are high, the fundamentals are good, most companies are having great quarters and the outlook is pretty good.”
The focus on valuations comes as investors assess various cross-currents that may influence markets in the coming months, including an expected slowdown in growth, a resurgence of COVID-19 cases in the United States and plans from the Federal Reserve to unwind the easy money policies that have helped prop up asset prices since the pandemic-fueled sell-off in March 2020.
Investors will get a new look at the economy next week with the monthly US jobs report and another batch of earnings reports from companies like Eli Lilly, CVS Health and General Motors.
Strong future earnings expectations have been the main driver of the S&P 500’s gains this year, according to a Credit Suisse analysis of the index’s performance since the start of the year that compared changes in stock valuations to changes. expected benefits.
Still better than expected earnings should keep valuations in check. Profits are now expected to have climbed 87.2% in the second quarter from a forecast of 65.4% in early July, according to Refinitiv IBES.
“If you have an environment like the one we are in, where companies are exceeding expectations by 18-20%, that means the P / E is lower than the official number,” said Jonathan Golub, chief equity strategist. American at Credit Suisse. . Credit Suisse expects the S&P 500 to end the year at 4,600, around 4% above Thursday’s close of 4,419.15.
Alphabet and Boeing, parent company of Google, were among the big wins this season. Investors were less satisfied with Thursday’s report from e-commerce giant Amazon, whose shares took a hit after saying sales growth would slow in the coming quarters.
Falling bond yields, with the 10-year rate recently falling to around 1.25%, has also boosted the relative attractiveness of equities.
The equity risk premium – a comparison of the return on earnings from stocks to the interest rate on bonds – is currently at a level that historically corresponded to a 12-month average gain for the S&P 500 of 15.2%, according to the Wells Fargo Investment Institute.
Goldman Sachs said in a recent memo that its S&P 500 year-end target of 4,300 is based on a 10-year yield of 1.9%. A 1.6% return, still more than 30 basis points above current yields, would bring Goldman’s estimate of fair value for the S&P to 4,700 by year-end, maintaining modeled growth and other constant factors, the bank said.
Still, some investors have become nervous about stock valuations, which are high by many historic measures despite recent earnings booms.
The cyclically adjusted price-to-earnings ratio, or CAPE ratio, which takes a longer-term view to adapt to fluctuations in economic cycles, is a blinking valuation indicator. It has reached its highest level in over 20 years.
The increase in the CAPE ratio is a factor that Cresset Capital Management took into account before slightly reducing its overall exposure to equities earlier this year for its portfolios which have an investment horizon of at least 7 years, said Jack. Ablin, director of investments at Cresset.
“Stock valuations are expensive, extremely expensive,” he said. “From this point of view, the market does not have a very convincing long-term future. “
Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Dan Grebler