Stock market hits highest valuation since 1999

The measures against the coronavirus are having a major impact on the economy, but that doesn't seem to deter investors. The stock market has already largely recovered from the sharp correction earlier this year, while earnings expectations are still more than 20% lower than before the crisis. As a result, shares measured by the price/earnings ratio are as expensive today as they were during the dotcom bubble in 1999. Also, based on this indicator, shares are now much more expensive than before the corona crisis.

Why is it that investors are flocking to equities? One possible explanation is that investors are still pricing in a V-shaped recovery of the global economy, with demand picking up again and corporate profits recovering. Another explanation is that the fall in interest rates has made it more attractive to invest in shares. In addition to a possible price increase, shares also yield dividends. That dividend is now higher than the interest rate on savings or government bonds. This also makes investing in shares interesting for savers looking for a higher return.

#Valuation tends to rise during economic crises as #earnings collapse. But with the forward #PE already at 25, how much higher can it go for the S&P 500 Index... pic.twitter.com/62xWG9bI2B

— Jeroen Blokland (@jsblokland) June 15, 2020

Are stocks overvalued?

Based on the price/earnings ratio, you would say that stocks have become relatively expensive at the moment. The profits of many companies have deteriorated significantly. The corona crisis is also expected to have an impact on the real economy. More bankruptcies and rising unemployment will have a negative impact on the disposable income of many households and thus also on the profit expectations of many listed companies. Whether corporate profits will return to the level of the beginning of the year remains to be seen.

The rally therefore seems to be mainly driven by measures taken by central banks. New asset purchase programs have further reduced interest rates on government bonds, making the dividend yield of equities more favorable. Another explanation is that investors speculate that central banks will also buy stocks in the future. Earlier this month, ECB Executive Board member Robert Holzmann Said that share buybacks cannot be ruled out. In Japan, the central bank is already buying shares, namely through so-called exchange traded funds.

Under normal circumstances, equities are valued based on underlying assets and expected corporate earnings, but in a world with very low and even negative interest rates, different rules apply. Defensive investors also seek refuge in equities, because they yield more returns than bonds. This has a price-pushing effect on the stock market.

Also Read: Warren Buffett ignores stocks

This contribution was made from Geotrendlines