Record U.S. Stocks at Lowest Valuation Since 1980Alexis Xydias and Whitney Kisling
Even after U.S. stocks more than doubled in the four-year bull market, companies in the Standard & Poor’s 500 Index are cheaper than at any record high since 1980 as individual investors shun equities.
The S&P 500 rose to within 1 percent of its high last week, gaining 131 percent from its lows. The index trades at 15.4 times reported profit, below the average 19.9 reached in bull markets since 1962, according to data compiled by Bloomberg. The Dow Jones Industrial Average erased all losses from the financial crisis on March 5 and has added 11 percent this year.
While individuals added almost $20 billion to U.S. stock funds this year, the amount is just 3.5 percent of the withdrawals since 2007 and compares with $44 billion placed with fixed-income managers in 2013, according to the Investment Company Institute. For bulls, the absence of private buyers shows there’s plenty of money to keep the rally going. Bears say the pessimism means the rally is too dependent on Federal Reserve stimulus and will fizzle once central bank support ebbs.
“I was down on the floor of the New York Stock Exchange when the Dow hit its new high and there weren’t any champagne corks popping or people getting excited,” Michael Holland, chairman and founder of New York-based Holland & Co., said in a March 14 phone interview. His firm oversees more than $4 billion. “Valuations are extremely low. When there’s an absence of really bad news, the path of least resistance is up.”
The S&P 500 increased 0.6 percent to 1,560.7 last week, bringing the year’s advance to 9.4 percent. The Dow average climbed to 14,514.11 after reaching a record on eight consecutive days. Americans filing for jobless benefits fell to the lowest in almost two months, retail sales increased more than forecast and the housing market strengthened.
The S&P 500 slid 0.7 percent to 1,549.43 at 9:51 a.m. in New York today as the euro area imposed a levy on Cypriot bank deposits to reduce the cost of rescuing the nation’s lenders.
About $10 trillion has been added to U.S. share values since the market bottomed on March 9, 2009, during the worst financial crisis in seven decades. Confidence among households was shattered by the S&P 500’s 57 percent plunge from its October 2007 highs.
Institutions have been the main beneficiaries of the rally. Individuals drained more than $600 billion from equity mutual funds in the six years though 2012 until becoming net buyers in January, data from the Washington-based ICI show. Even now, private investors remain skittish, withdrawing an estimated $1.7 billion in the two weeks through March 6 and pushing $10.5 billion into bonds.
“This big rotation from bonds to equities is not in full swing,” Alan Zlatar, who helps oversee $65 billion as head of multi-asset class investments at Vontobel Asset Management in Zurich, said in a phone interview on March 13. “Our clients are seeking returns, and so far most of them have tried to stay within the bond space. What speaks in favor of equities is, of course, that the alternatives are extremely pricey.”
Stocks are close to the least expensive ever versus government bonds, using a valuation method favored by former Fed Chairman Alan Greenspan that compares earnings with interest payments. S&P 500 companies currently generate profit equal to 6.5 percent of their share prices, about 4.5 percentage points more than yields on 10-year Treasuries. The average spread in the past 10 years was about 2.5 percentage points, data compiled by Bloomberg show.
The combination of stocks near all-time highs and declining trading volume indicates money isn’t coming into the market and that equities are rising because fewer people are selling, according to Murray Roos, co-head of European equities at Deutsche Bank AG in London. On average, 2.53 billion shares changed hands in S&P 500 companies each day this year, Bloomberg data show. That compares with 3.59 billion from 2009 to 2012.
“There aren’t sellers, that’s why the equity market is looking fundamentally cheap,” Roos said. “We’ve got latent demand for equities. We are at the start of a protracted move up in equity markets.”
Investors still have reason to be concerned because the rally has been fueled by unprecedented Fed stimulus, according to Stewart Richardson at RMG Wealth Management LLP. The central bank has lowered the target interest rate on overnight loans between banks to almost zero and is purchasing $85 billion a month in bonds to boost the economy.
Fed Chairman Ben S. Bernanke’s pledge to spur growth helped stem some of the biggest declines since the bull market began. The S&P 500 ended a 14 percent drop and began a 30 percent advance on Aug. 26, 2010, after Bernanke said he “was willing to do everything in his power” to stimulate growth.
The index has climbed 42 percent since October 2011, the month after he announced a policy to replace holdings of short-term Treasuries with longer-term bonds. The S&P 500 had been on the verge of a bear market, down 19.4 percent, over the previous five months.
“The rally has been a direct reflection of Fed policy,” Richardson, who helps oversee $100 million as chief investment officer at RMG in London, said in a March 14 phone interview. “The low volume means investors are not comfortable or bullish, it is just people putting money to work as they don’t want to hold cash. As soon as the Fed indicates they will stop printing money, that is a big issue for capital markets.”
While brokerage clients have bought equities this year, professional investors are liquidating some of their stocks, data from Bank of America Corp. clients show. Institutional managers who oversee money for pensions and other benefit programs sold a net $2.9 billion of shares through the New York-based bank in 2013 and hedge funds reduced their holdings by $461 million, according to a report dated March 12.
“The individual investor doesn’t seem like they’ve come back to the market yet,” Joseph Veranth, chief investment officer at Dana Investment Advisors in Brookfield, Wisconsin, said by telephone. The firm manages $3.8 billion. “People aren’t convinced this is for real. They’ve been burned twice in a big way, and there’s still doubt.”
Valuations in the S&P 500 have stayed below historical averages after profits almost doubled since 2009. Per-share earnings are estimated to reach $109.50 this year from $61.84 in 2009, according to more than 11,000 analyst forecasts compiled by Bloomberg. Today’s multiple of 15.4 times reported earnings is up from the bull market’s low of 11.7 in September 2011.
The price-earnings ratio averaged 18.1 in the five-year rally through October 2007 and 20.9 during the gains in the 1990s, data compiled by Bloomberg show. While the bull market that began in 1990 started off with a multiple about 14, it exceeded 20 within a year. Valuations during the 2002 advance didn’t fall below the 16.4 historical mean until the cycle’s fourth year, data compiled by Bloomberg show. The only time stocks were cheaper as the index rallied to a high was in 1980, when they traded for 9.1 times profits.
The rise since March 2009 has been led by media companies such as CBS Corp. and Gannett Co., and industrial firms including International Paper Co. New York-based CBS, owner of the most-watched U.S. television network, has jumped more than 15-fold and Gannett, the McLean, Virginia-based company that publishes 82 U.S. daily newspapers and owns 23 television stations, has rallied 11-fold. International Paper, the world’s largest maker of cardboard packaging, has surged 10 times.
Commodities producers including Cliffs Natural Resources Inc. in Cleveland, Ohio and San Antonio, Texas-based Tesoro Corp. paced gains in the last bull market, which lasted five years through October 2007, data compiled by Bloomberg show. Technology stocks such as Dell Inc. and Cisco Systems Inc. led the rally that ended in March 2000.
“Those investors choosing not to favor equities in their strategy in favor of a bond allocation are locking into low returns,” Ashish Misra, who helps oversee $17 billion as head of investment policy and research for Lloyds TSB Private Banking in London, said in a phone interview on March 13. “The economic growth outlook has not been this universally constructive for a long time. The wall of worry is very much out there for investors to climb before markets seek higher levels and more historically normal ratings.”