Content provided by Kostya Etus, CLS Associate Portfolio Manager
The word “overvalued” has been thrown around a lot lately, specifically when referring to the U.S. stock market. But, this kind of classification needs to be put into perspective and backed up with data. The idea of elevated valuations is that they tend to lead to reversions to the mean, and thus a higher likelihood of price declines in the future. So, how exactly does the U.S. stock market look as of late? The Bank of America chart below shows the ratio of U.S. stocks versus the rest of the world, and as you can see, it is at record highs. In fact, it is above both the tech bubble and financial crisis spikes.
Typically, valuations are fundamental in nature and not just a measure of price performance, but instead price multiples. Take a look at the below charts of median price to earnings (P/E) and median price to cash flow (P/CF), a couple of the most widely used measures for fundamental valuation. As you can see, these measures are also at record highs, thus pointing to the fact that a reversion to the mean is more likely in the U.S. market. This is a time of increased volatility, which also means increased potential for opportunities. While we are cautiously optimistic on the U.S. market, we are constantly looking for opportunities abroad, where valuations are low and the possibility for upward reversion is higher.