The Wall Street Journal reports,"with earnings season winding down, stock investors find themselves in essentially the same spot as the beginning of the year.
Fourth-quarter profits were better than expected but weren’t strong enough to bring stock valuations substantially lower. Revenue growth disappointed and corporate outlooks were muted, giving investors some pause about what lies ahead''.
“We continue to believe that the weight of valuation evidence suggests the S&P 500 is significantly overvalued at its current levels,” said James Montier, a member of the asset allocation team at GMO, the famously contrarian Boston investment firm. “Some call us ‘valuation bears’; we argue that we are simply valuation realists.”
The team at GMO looks at a confluence of metrics when making their valuation call, including Nobel-winning economist Robert Shiller’s cyclically adjusted price/earnings ratio. The so-called CAPE ratio, which aims to provide a long-term comparison point for stock valuations, uses the last 10 years’ worth of profits and controls for inflation. It sits at 25.56, well above the long-term average of 16.52.
Other valuation metrics tell a similar story.
The S&P 500 is trading at 15.1 times next year’s earnings estimates, down from 15.3 at the end of last year, according to FactSet. The current level is above both the five-year average of 13.1 and the 10-year average of 13.9.
Entering 2014, Wall Street strategists warned that this year would differ from 2013 in a key way: Valuations wouldn’t be able to keep rising at the rate they did last year.
In 2013, stocks rose faster than earnings as investors expressed optimism that faster profit growth was around the corner. As a result, the S&P 500’s forward P/E ratio rose to 15.3 from 12.7, FactSet data show. That marked the largest expansion in the P/E ratio for stocks since 2009, when the market was recovering from the depths of the financial crisis.
The P/E ratio is a valuation of a company’s share price compared to its per-share earnings. The ratio also is known as the stock’s multiple.
As expected, multiple expansion has stagnated through the first two months of the year amid an earnings season that has yielded mixed signals. With 90% of S&P 500 companies having reported quarterly results, fourth-quarter profit growth is up 9.6% from a year ago, according to data compiled by Thomson Reuters, the highest growth rate in two years.
Revenue has risen only 1% from a year ago. And three out of every four companies providing first-quarter guidance released figures that fell below Wall Street’s estimates, which suggests companies may struggle maintaing strong profit growth in the coming quarters.
With the economy starting the year weaker than many expected and stocks still looking relatively pricey, the S&P 500 will need new positive catalysts in order to jump back to record highs and beyond.
