While this writer is on record as expecting that 2023 will be a good year for equities, it is always sound practice to be cautious and consider counter arguments. Therefore, we list below a number of valuation metrics that highlight some of the key concerns with the US market at present.
US equity market valuations appear somewhat expensive at present. First, in absolute terms, the forward price to earnings (PE) at 17.4x is above the long-term low inflation era average of 16.4x. Trailing earnings are at 19.5x, but the market is focused on the future, not the past. Much will therefore depend on the earnings US corporates are able to deliver this year, and expectations for next year.
Source: Yardeni Research
Second, relative to bonds, the yield gap is the worst since 2007, pre-GFC. The yield gap is the difference between what equities are yielding (earnings per share as a percentage of their share price) and the yield on 10-year bonds. US 10-year treasuries are presently yielding around 4.0%.
Third, against short-term rates, the yield gap is the worst since 2001, close to the peak of the tech bubble.
Fourth, while the dividend yield at 2.1% is around average, compared to US bonds, again, it is unattractive.
Finally, against inflation, the market appears very expensive. The market is assuming a fairly quick return to low inflation with interest rates moving lower than current levels over the medium term. This may turn out more hope than fact. As always, only time will tell.
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