With the global stock market at its all-time highs, we want to highlight the current valuation dynamic and a few of the forces driving US stock prices.
The current forward price to earnings multiple of the MSCI All World Stock Index is 18x. This puts the present valuation ratio at the 93rd percentile—meaning that 93% of the time over the last 20 years, the global stock market has traded at a lower valuation. Over those two decades, this market has had a median valuation based on forward p/e of just under 15x.
As you can derive from the graph, this extreme valuation is being driven by US stocks with a forward p/e of 22x. The US markets are currently above the 95th percentile of valuation. Japan, Europe and even Emerging Market stocks look reasonably priced relative to their historical ranges.
So what is driving the current US valuation extreme? Well we think it is a combination of:
- Price insensitive corporate stock buybacks
- Very low corporate yield spreads
- Enormous government deficits
So far this year, US companies have repurchased nearly $1 Trillion of their stock. These purchases are most commonly price agnostic, meaning that the buyback is not based on any assessment of share value.
Corporate yield spreads (the extra interest that companies pay above the Treasury yield) have declined significantly since the October 2022 recent stock lows. The US High Yield Avg OAS has fallen from 5.83% to just 2.84% today.
This spread compression lowers borrowing costs for companies and reduces the implied discount rate of stocks.
Congress suspended the debt ceiling in June of 2023. Since then, the National Debt has increased by over $4 Trillion. Think about that—in a little more than 15 months the government has spent $4 Trillion more than its revenues. A lot of this money has found its way into corporate coffers and into the stock market.
We aren’t calling for an immediate correction in US stock valuations. In fact given the current trend of monetary policy around the world, it’s likely that stock valuations continue to stay elevated.
We just want you to be aware that US stocks aren’t cheap. They are being supported by government largess, corporate buybacks and easy borrowing. If any of these supports begin to weaken, stock prices might weaken as well.
We are closely monitoring the data for signs of economic weakness, but for now most of the data is showing full steam ahead.
