The battle between the bulls and bears is heating up once again, with much of the basis for this ongoing conflict surrounding equity valuations and whether they offer any upside to investors, or merely just risk. Do we see a bubble in equity valuations given the second longest bull market in history has received another dose of returnadrenaline?
While valuations are clearly no longer cheap, we do not find broad valuations to be excessive either. In fact, DM and EM valuations are around average when considering the past two decades. It is important to note the period considered is influenced by the extremes of the tech bubble in the 1997-2000 period – a 'proper' bubble when comparing valuations then and now – which skews the average upwards.
While stocks and valuations have clearly risen strongly, to the extent many markets are trading around cyclical highs reached in 2007, there is a case to be made that the re-rating has foundation when looking forward. From their depths in early 2016, economic indicators have been rising steadily, led by upside surprise in manufacturing and service PMIs, while earnings revisions continue to move in the right direction. Often the key to success in mature bull market periods is resisting the temptation to be too bearish, too soon, as long as the improvement phase is real and valuations are not unrealistically high.
We see enough improvement to maintain optimism the equity cycle can deliver returns, even from this current valuation starting point. Policy missteps and pull-backs are almost inevitable, however, certainly as we extend our time horizon. The bears will have their day, but we do not believe it is today, and we do not believe equities embody a valuation bubble looking at current data.