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Pricey stocks? They've been dear for decades

Invesco economist John Greenwood warns investors not to place too much stock in some historical valuation methods for shares.

Pricey stocks? They've been dear for decades

Stretched equity valuations are raising fears of a bubble but you have to go back a long way for a time when stock markets really were 'cheap', says Invesco Perpetual's John Greenwood.

Greenwood, chief economist at the fund group, said historically high valuations have led commentators to point out how overpriced stocks are based on the Shiller cyclically adjusted price earnings (Cape) ratio.

The Shiller Cape ratio was developed by Nobel Prize-winning economist Robert Shiller, and is a ratio of the price of a stock over its average 10-year earnings, adjusted for inflation.

‘Today this ratio stands at 33.6 higher than the peak reached before the great stock market crash of 1929, and surpassed only by the internet bubble period around 2000,’ said Greenwood.

‘The fear now is that, with equity markets so overvalued, they must be heading for a fall.’

However, Greenwood pointed out that since 1985 this ratio has ‘persistently been above its long-term average, apart from a brief period in 2009, when investor confidence was severely knocked by the global financial crisis’.

‘The implied message here is that not investing in stocks over the past 30 years or so would have been the right decision - an expensive mistake with hindsight,’ he said.

Instead of relying on the Shiller Cape ratio in isolation, Greenwood argued equity valuations should be looked at in the context of bonds, which means adjusting the ratio to ‘create an implied earnings yield and second we deduct from it the yield of the benchmark 10-year US Treasury bond’.

He said this shows ‘equities were expensive relative to bonds from 1985 to 2009 but since then the relationship has reversed’, meaning that despite share price increases ‘equities remain more competitively priced than bonds’.

'Late cycle' market

James Bateman (pictured), chief investment officer for multi-asset at Fidelity International, sees the recent sell-off in stock markets as a buying opportunity, but that it is prudent to avoid areas of 'excess valuations'.

‘This is a return to normality rather than a departure from it,’ he said. ‘I continue to believe that recent market declines represent a buying opportunity.’

He admitted that bear markets could ‘appear out of nowhere’ but strong macroeconomics and ‘solid fundamentals’ pointed to the beginning of the ‘late cycle, but not the end of the cycle itself’.

‘Experience tells us that a ‘late cycle’ environment can last anything from a few months to a couple of years, so while we should expect continued volatility, not is not the time to capitulate - remaining cautiously risk-on feels the right approach,’ said Bateman.

'I favour a rotation into more traditionally ‘value’ areas of the market, which have substantially lagged so far in the cycle. These in effect are a two-way position: if markets resume their uptrend, a shift in leadership is highly probable, while if markets fall these stocks typically lack the excess valuations that exist elsewhere in the market.'

Real world versus robots

David Jane, manager of Miton’s multi-asset fund range, said he 'cautiously' welcomed the injection of more volatility into markets as it would throw up more opportunities.

‘It is reasonable to expect volatility to settle at a higher level than before, firstly as we expect higher interest rates as we exit the quantitative easing era, but also because the short volatility and risk parity traders now understand better that the trade is not risk free,’ he said.

Jane argued the algorithm-driven trading had the potential to deliver more shocks to stock markets, as any uptick in volatility was likely to be met with automatic selling of risk assets like shares.

'We would expect markets to remain bumpy as the battle between the real world and the computers may continue for some weeks yet but for a long-term fundamental investor, this should be seen as offering up opportunities not a reason to be fearful.'

7 comments so far. Why not have your say?

Canny Lad

Feb 16, 2018 at 16:42

Far be it from me to take issue with the esteemed John Greenwood, but valuing equities against bonds at a time when the latter are not far from all time highs (and regarded by many as a bubble market) strikes me as being rather inopportune. And the knee-jerk reassuring noises about the 'correction,' from the career-risk financial commentariat, only serve to remind me of Benjamin Franklin's quote: "When everyone's thinking alike, then no one is thinking."

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Feb 16, 2018 at 18:03

With a nod to history and lessons not learned being repeated, surely there's a point back in time at which analysis of historical data to derive anything but historical outcomes becomes utterly redundant in the present, let alone in divining the future.

In a world of banking syndicate omnipotence, corporate welfare, robotic trading, financial engineering, doctored government metrics and unpayable national debt, it's anyone's guess where things are heading.

More of the same would be my best guess, that said I'm holding a diversified global equity investment portfolio for the long term, come what may.

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King Lodos

Feb 16, 2018 at 19:08

Green's absolutely right .. At any one time you have two basic choices: do I buy bonds on yields of 2%, or stocks on earnings yields of 5%?

Right now, stocks are much better value.

That doesn't tell us about the future, but if any of us *knew* yields were going higher, we'd all be short long-dated bonds

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King Lodos

Feb 16, 2018 at 19:09

And sitting on the sidelines – as many investors in the 90s did – is a gamble in itself.

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Alastair Kendall

Feb 16, 2018 at 23:36

It's different this time.

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Mr Helpful

Feb 17, 2018 at 10:49


For practical purposes it might be prudent to look at valuations over shorter periods, rather than over the full lKrondatief long-wave.

As for this binary decision business, sitting on the side-lines in Cash, or being 100% committed to Stocks, rather than a measured proportional response; it seems this Straw-Man will never be slain?

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Alastair Kendall

Feb 17, 2018 at 21:04

20% Gold; 20% cash or cash equivalents; 20% hedge funds including long-short equity; credit derivatives and managed commodity futures; 10% commodities and 30% equities.....who knows what to do in these difficult to navigate times? For sure, it won't be different this time .....just bigger and more spectacular, and every asset seems to move in unison. I think the next crisis will be about the very nature of money itself and it ain't going to be pretty. I'm off to buy another goat and some more seed potatoes.

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