2020.10.12 – A Valuation Puzzle: Rising Stocks And Recessions

$ 499 + HST

EXECUTIVE SUMMARY

One of the investment puzzles of 2020 is the stock market’s behaviour. In the face of the worst global economic downturn since the Great Depression, why haven’t stock prices fallen further? Investors saw a brief panic in February and March, and the S&P 500 has recovered and even made an all-time high in early September. As a consequence, valuations have become more elevated.

One common explanation is the unprecedented level of support from central banks around the world. Interest rates have fallen, and all major central banks have engaged in some form of quantitative easing. Let’s revisit the equity valuation question and determine the future outlook for equity prices.

The S&P 500 is trading at a forward P/E ratio of 21.9, which is well ahead of its 5- and 10-year averages. In light of the BIS analysis, the forward P/E ratio of about 13 reached during the March low represents a reasonable level of bottom-of-cycle valuation in light of the lower interest rate regime.

Investors who missed buying the March low may find a second chance in the near future. From a technical perspective, past recession-related equity bear markets have seen an initial low, followed by one or more re-tests of the first low. In some cases, the re-test was unsuccessful and the S&P 500 fell to a lower low before launching into a fresh bull. The time between the first and final low can be as long as over a year.

No matter how the fundamental develop, the S&P 500 and U.S. growth stocks have low upside potential compared to value stocks and other developed market equities.

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