James Tierney: Is the price still right?

November 9, 2017

2 minute read

by James Tierney, Chief Investment Officer—Concentrated US Growth, AllianceBernstein

We’re thrilled that markets are where they are, to be fair. But I think you have to look at valuation on two fronts. You have to look at relative valuation and absolute valuation.

Looking at absolute valuation first, are we in the higher half of where we’ve been historically in terms of P/Es? Without a doubt. That said, look back to 2000 and we were in a mid-25 range—mid-20s range on P/Es. That was really expensive. Around 20 right now, we’re just moderately expensive.

On a relative basis, you have to look across asset classes. And when you look at an earnings yield of the S&P 500 at around 5%, and you compare that to a bond yield of a 10-year Treasury at 2.30 or 2.35 today, equities are still cheap compared to bonds. Now I think the Fed will fix that by continuing to raise rates, but I don’t think you have to start worrying about valuations at this point in time by any means.

Are you going to raise rates because growth is accelerating? Or are you raising rates because we want to get back to normal?

So, that’s the big question. If it’s the first case, then absolutely, P/Es could stay where they are if not go up. If you’re just getting back to normal, which is to a degree what the Fed has been doing the last couple of years, then I think we might be capped out in terms of an equity P/E. And remember, so much of the return of the equity market over the last three or four years has been from higher P/Es. What does that mean for the investor? You really have to find companies that have true earnings growth. So, the onus goes back to earnings growth and secular growth companies as opposed to all boats being lifted by a rising P/E.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.