Stocktake: Have market valuations fallen enough?

Market valuations have fallen in 2022, but have they fallen enough? No, says Morgan Stanley’s Lisa Shallett, who warns valuations have “reinflated” following the recent rally, with the S&P 500 now trading at 18.7 times estimated earnings. The equity risk premium – the extra return you can earn by investing in stocks over risk-free assets – is around 2.6 percentage points, well above the 13-year average.

Additionally, current earnings estimates look “unrealistic”, cautions Shallett. In contrast, JPMorgan’s Marko Kolanovic last month noted the S&P 500′s price-earnings (PE) ratio had fallen by 6.7 during the first half of 2022. That’s the second-biggest valuation decline in 30 years, he said, and well above that seen during prior recessions. Now, one could argue this outsized PE decline is less impressive than it sounds, that it merely reflects how expensive stocks were in early 2022. Kolanovic has since returned to the subject of valuations, saying he is often asked how the current market multiple can justify further upside.

His answer: valuations are less important than positioning. If the S&P 500 climbs above its 200-day moving average and breaches certain momentum metrics, says Kolanovic, it could catalyse some $100 billion (€100 billion) in inflows from trend-following strategies. Add in corporate buybacks, and stocks could see steady inflows in coming months. Perhaps, but Friday’s carnage suggests the index won’t be breaching the above-mentioned levels any time soon.