Syringes of the AstraZeneca/Oxford Covid-19 vaccination ready to be administered on February 1, 2021 in the vaccination centre at the Royal Cornwall Showground Wadebridge, England.
Hugh Hastings/Getty ImagesStocks aren’t exactly cheap right now, yet companies are increasingly confident in the future. Investors may need to walk a tightrope.
Stocks are mildly cheaper than they were a week ago. A multiday selloff pushed the S&P 500 down more than 4%, but with the index up Monday, it is still a few percentage points below its all-time high. Some think the market is due for a correction, the process of which may be under way.
One major cause of the selling was the retail-driven run-up in a few names, which forced funds that were short those names to buy the stock back and meet requirements with brokers. They had to sell out of long positions to raise the cash needed, which may also underscore that investors were already low on cash and their long holdings were already overextended.
Still, market valuation metrics look stretched,” wrote Tobias Levkovich, chief U.S. equity strategist at Citigroup. It isn’t just that the forward price-to-earnings ratio on the S&P 500 is 21.6, above a long-term average of 15 times. Even adjusted for ultralow interest rates, which drive valuations higher because they boost the value of future profits, these multiples are arguably elevated.
The equity risk premium—or the earnings yield on the S&P 500 minus the 10-year treasury yield—leaves an expected extra return on stocks of 3.5%. That is a level stocks tended to gravitate toward since the start of the post-financial crisis bull run, according to a chart from Morgan Stanley strategists.
But when stocks yield 3% or below, danger often lurks. One could argue that the equity risk premium is still too high,” Levkovich noted, before listing several uncertainties, like potentially higher corporate taxes and Covid-19 vaccine snafus, the market’s biggest risk. There may be good reason to have higher-than-normal risk aversion,” Levkovich argued.
He did note valuation “is not the best timing indicator,” meaning high multiples don’t necessarily mean stocks are soon to fall; the market can hold at elevated valuations for some time, while more technical indicators are more indicative of near-term price movements. Either way, valuations aren’t cheap.
Meanwhile, corporate management teams are highly confident in the future. According to Bank of America’s language processing analysis used on earnings reports, corporate sentiment is as high as it has been since 2004, as companies see vaccines spurring 2021 reopenings, which can be met by pent-up consumer and corporate demand resulting from of economic stimulus. The bank’s corporate sentiment score is higher than it has been in 17 years, which historically favors cyclical stocks over defensives, the banks says, because it signifies a strengthening economy.
Valuations and sentiment are sending conflicting messages on whether to buy stocks. Stocks may be due for a correction, but if the vaccine narrative holds, investors would want to buy that dip. If the vaccine narrative falls a part, valuation could be in for a reassessment.
Be tactical.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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February 02, 2021 at 08:29AM
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Stocks Are Expensive. What Investors Need to Know Now. - Barron's
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