As the equity bull market enters its seventh year, investors are rightly concerned about its longevity. While the recovery in the global economy has supported earnings growth, much of the six-year rally has been driven by multiple expansion. After bottoming in 2009, the trailing price-to-earnings ratio (PE) on the MSCI World Index of developed countries has expanded by more than 70%, from 10.2 in late 2008 to nearly 18 today. In certain countries, notably the United States, a significant part of the gains in recent years has come from investors willing to pay more for a dollar of earnings.
However, while stocks are no longer cheap and certain markets appear expensive, valuations are not yet at a level consistent with market peaks. Low inflation and historically low interest rates also support valuations. This does not ensure further gains, but it does suggest that valuations, by themselves, are not the major impediment to stocks moving higher.
Where does that leave investors? There are three important takeaways:
- Current valuations suggest more modest gains in several developed markets, particularly the United States.
- With valuations at these levels and the Federal Reserve (Fed) on course to begin raising interest rates later this year, further gains are likely to be accompanied by more volatility.
- International markets, including emerging markets (EM), stand out as more reasonably priced than the United States.
Find out more about the outlook for stocks going forward, how they can still move higher, and where we see value in this month's Market Perspectives.