The overvaluation from long-term averages for US stocks in recent years has been well known
to equity investors. Unfortunately, valuations give you no information on timing – they tell you
how far you’re likely to fall, but not when. The virus, specifically the “cure” for the virus, was the
proximate cause for the fall in valuations we have seen since February, but in truth it could have
been triggered by many other events. Nevertheless, the correction in valuations has not led to a
free-for-all, where buying almost any stock will turn into a great long-term buy.
First of all, the breadth of overvalued stocks was much greater this time than the two previous
market tops. The top-left chart shows a much fatter distribution of P/Es in February 2020
compared to the 2000 and 2007 tops (bottom-left chart). The recent correction has caused
valuations to fall, but the distribution of stock P/Es (top-right chart) is not dissimilar to the 2000
and 2007 markets at their peaks. Discernment from investors is still required to avoid overvalued
stocks, despite the fall in valuations. Moreover, it takes on average almost three years after a
bear market begins for the index’s CAPE to bottom (last chart; prices may bottom first though, as
happened in the 1974-1980 period, when prices rose but P/Es kept falling). We outline in our
recent Thematic for clients, Crisis Management, key stocks to own and those to avoid.
Source: Bloomberg, Macrobond and Variant Perception