Elevated Equity Valuations

The article below is from our BRIEFINGS newsletter of 19 March 2021

With markets hitting new highs, are equity valuations at a peak? We sat down with Candice Tse, U.S. head of Market Strategy within the Strategic Advisory Solutions team in Goldman Sachs’ Asset Management Division, who shared her view on the current valuations. 

Candice, with markets continuing to set new records, are equities getting too expensive?

Candice Tse: We’re getting a lot of questions from investors about current valuations. On an absolute basis, valuations are high across many traditional metrics. By most measures—including Price/Book, CAPE and Forward P/E ratios—stocks are trading in the top decile historically. At these high levels, it’s no surprise that investors are contemplating the risk-reward tradeoff of investing in U.S. equities. On a relative basis compared to Treasury yields, equities are more fairly valued. But even operating under the assumption of elevated valuations, our analysis shows that the equity market can stay expensive for years, especially when paired with accommodative policy and stable inflation. In fact, the last 10 years are a great example. Valuations have remained consistently high over the last decade, yet the U.S. equity market, as measured by the S&P 500 Index, was still able to generate 227% in cumulative total returns during that time as of Feb 1, 2021.

What does the recent volatility in equities mean for investors?

Candice Tse: Moments of volatility may actually present potential opportunities to invest. While valuations matter, economic fundamentals can matter even more. Research shows that the early stages of an economic recovery are often accompanied by bullish market sentiment that’s driven by recovering fundamentals and a favorable growth picture. Historical S&P 500 data tells us that economic expansions have generated positive returns 87% of the time; and 67% of the time, returns were at least 10%.

So what’s your outlook for equity markets this year?

Candice Tse: We remain pro-risk. Our view of risk assets, particularly in global equities is supported by a number of factors including recovering global growth, double digit corporate profits, limited need for structural repair, continued policy support and relatively low global interest rates. Even as the S&P 500 was up 78% from the market bottom in 2020 as of March 17, 2021, those gains only reflect one-fifth of the median returns seen during the last four expansionary cycles. These past equity rallies lasted for a median of 109 months with gains over 400% from the market bottoms. We expect that broader vaccination efforts, warmer weather and a cyclical rally from COVID-19-sensitive sectors are likely to extend tailwinds that will be supportive of the equity market despite high equity valuations. Ultimately, our expectation for double-digit returns this year is supported by a sharp V-shaped recovery due to the vaccine rollout, and supportive fiscal and monetary policies.