But there’s some good news for investors with cash to allocate: valuations have gotten a lot more attractive.
The price-to-earnings (PE) ratio — the price of the S&P 500 divided by the earnings of those S&P 500 companies — is probably the most popular way to measure value in the stock market. And because prices have come down so much, so have those valuations.
“[T]he valuation correction does seem in place,” Citi’s Tobias Levkovich wrote.
In a new note to clients, Deutsche Bank’s David Bianco notes that “valuation is back to normal.” The PE based on trailing 12-month earnings is back to its long-run average. While the PE based on expected earnings for the next 12 months remains a hair above average, Bianco thinks it’s nevertheless attractive.
Keep in mind: The mayhem in the markets has occurred with little regard to what is going on in the economy, which has been holding up and has been bolstering expectations for earnings.
“The forward PE is 15X currently, lower than the implied PE of corporate bonds (inverse of yield) and barely above HY (which is barely at a discount),” FundStrat’s Tom Lee said on Tuesday. “[S]tocks are -0.6 standard deviation from long-term average, or cheap.”
Barclays’ Jonathan Glionna also pounced on this.
“[T]he S&P 500 PE ratio fell to 15.5x, a level not seen since October of last year,” Glionna wrote on Tuesday. “As shown in our poster report titled Is 17x earnings expensive?, the S&P 500 total return for the next 12 months has averaged over 11% and 20% for PE ratios of 15x and 16x, respectively.”
But just so we’re clear …
To be clear, every one of these strategists warn we could continue to see lots of volatility in the markets in the near-term. And for many, the observation about valuations is just one component of a much more complex investment thesis.
Furthermore, we’d add that valuations don’t offer a lot of predictive power when it comes to next-12-month returns. Indeed, they tend to drift for long periods of time, which means prices could keep falling making valuations even more attractive.
But for the longer-term investor who is willing and able to weather some volatility, the entry point hasn’t looked this good in months.
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