Home|Who We Are|Our Services|Resources|News Center|Contact Us|Client Access
More Articles  Printer Friendly Version

 

The Paradigm Shift In Valuing Stocks

(Friday, July 24, 2020, 8:15 p.m.) After the Covid-induced bear market, when the 500 largest stocks lost 34% of their value, share prices recovered swiftly. By late July 2020, America's largest public companies traded at nearly 20 times their previous 12-month reported profits, and suddenly fears grew that a stock bubble was about to burst.

While no one can predict the next stock-market move with certainty, what's clear is that the stock market's valuation metrics have changed with the financial times. Under the current regime of ultra-low-bond yields -- a condition not expected to change anytime soon -- a new stock valuation paradigm has taken root.

Low yields on bonds make stocks more attractive investments, altering the historical relationship in the respective valuations of the world's two most fundamental investments. A higher price-earnings multiple for stocks is therefore justified by low bond yields.

A price-earnings (P/E) multiple of 20 in a "permanently” low-inflation environment is different from periods of high P/E's in the past. This is precisely why financial ads always warn, "past performance is not indicative of future results.” Current conditions make it seem obvious that the future will not look like the historical past.

To illustrate, during the tech stock bubble of 2000, when the Standard & Poor's 500 price spiked to nearly 30 times trailing 12-month earnings, the yield on a 10-year U.S. Treasury bond was 6%. Compare this to a recent 10-year bond yield of six-tenths of 1%. During the tech bubble, bonds yielded 10 times as much as they do now in the current environment! Furthermore, inflation during that period of sky-high stock valuations was more than 2%, versus one-half of 1% recently. And since inflation is not expected to spike higher any time soon, this keeps bond yields from rising.

In addition to this perceived shift in the stock valuation paradigm, modern financial markets differ from the past in another important way. In the U.S., since the 1980's expansion of individual retirement accounts and federally qualified retirement plans, American retirees and pre-retirees have grown into a permanent investor class. These individuals are incentivized by tax laws to stay invested for a lifetime. They are not so much concerned with the market's short-term gyrations. The hedge funds, Wall Street traders, and "hot money” investors are the proximate cause of much of the volatility, but their destabilizing behavior is widely ignored by the investor class as they recognize the slow, inexorable progress America's largest public-company investments represent.

The Standard & Poor's 500 stock index closed Friday at 3215.63, down a fraction from a week ago and 35.9% higher than its March 23rd bear market low.

Stock prices have swung wildly since the crisis started in March and volatility is to be expected in the months ahead.

Assets invested for life need not be influenced by the near-term risk of the virus crisis.


The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market-value weighted index with each stock's weight proportionate to its market value. Index returns do not include fees or expenses. Investing involves risk, including the loss of principal, and past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.

Nothing contained herein is to be considered a solicitation, research material, an investment recommendation, or advice of any kind, and it is subject to change without notice. It does not take into account your investment objectives, financial situation, or particular needs. Product suitability must be independently determined for each individual investor.

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions.


Email this article to a friend


Index
Positive Earnings, Housing, and LEI News; Stocks Closed Week At A Record
Today Versus Post-War History Of U.S Economic Cycles 
Stocks Surged 1.1% Today, Closing At A Record High For The Third Straight Week
Strong Jobs Report Confirms Recovery
What's Ahead For The Second Half Of 2021?
Despite Strong Economic News, Stocks Dropped This Past Week
Stocks Closed At A Record High; What's Expected For The Rest of 2021?
Jobs Situation Report Pushes Stocks A Fraction From All Time High
Inflation Rate Doubled In Past Two Months
Fed Signals It's Thinking About Starting To Talk About Tightening
Expect Inflation To Make Investors Nervous Through 2021
Stocks Closed At A Record, Ignoring A Bad Jobs Report
Stocks Soared 5.2% In April; Now, For The Good News
A Window Of Opportunity Is About To Close
Retail Sales, Housing Starts, And Stocks Rocket Higher
The Fed Is Not Braking The Boom Anytime Soon

This article was written by a professional financial journalist for Responsive Financial Group, Inc and is not intended as legal or investment advice.

©2021 Advisor Products Inc. All Rights Reserved.
© 2021 Responsive Financial Group, Inc | 204 W Wing St, Arlington Heights, IL 60005 | All rights reserved
P: 847-670-8000 | F: 847-590-9806 ben@rfgweb.com |
Disclosure | Contact Us
Responsive Financial Group, Inc. is a fee-only registered investment advisory firm in the State of Illinois. Information on this site is compiled from multiple locations and is believed to be accurate. Incorrect information may come from these outside sources. Should you notice anything please notify us immediately. Thank you!