US equity valuations reach near two-decade high after rally

The US stock market has surged over the past month despite the damage to corporate profits from coronavirus, pushing one popular measure of equity valuation to its most expensive in nearly two decades.

Corporate earnings are set to tumble this year as economic activity slows, wiping a third from company profits in 2020 compared with last year, Goldman Sachs estimates. At the same time, the US central bank’s unprecedented capital-market interventions and the government’s $2tn stimulus package have drawn investors back into the stock market, dragging the S&P 500 benchmark up 25 per cent since its low on March 23.

The rally has pushed the forward price-to-earnings ratio for the S&P 500 above 21 to its highest level since December 2001 — during the final stages of the dotcom bubble. The ratio reflects the price put by investors on future profits and is one of the most popular tools for investors to value stocks.

Some portfolio managers warn that this expansion in the earnings multiple has left investors at greater risk from stale forecasts. Wall Street analysts have faced extra difficulty in gauging earnings given many US blue-chips have withdrawn full-year profit guidance, citing the uncertainty posed by the pandemic.

“A lot of companies are not giving guidance and it’s harder for analysts to revise their numbers,” said James Wong, a portfolio manager who runs the equity group of Payden & Rygel, a fund manager based in Los Angeles. “They’re looking for guidance and without it their numbers are a shot in the dark.”

In the past few weeks of first-quarter earnings, companies including Wells Fargo, IBM and Uber have scrapped the full-year profit guidance they typically share with analysts.

“I would have to close my eyes and throw a dart at a dartboard to guess what earnings will be this year,” said Terri Spath, chief investment officer of Sierra Investment Management also in Los Angeles. “It’s too challenging to put a number to it — this complete contraction of the economy is very painful.”

The lack of clarity about corporate profits has not held back the sharp rally in US stocks. The S&P 500 rebound since the March low follows the fastest fall into a bear market in history, and has eased the loss for the year to 13 per cent. Some investors are looking past 2020 altogether, with an eye towards 2021 and a hoped-for rebound in economic activity and earnings.

But others remain focused on near-term valuations. “I’m concerned that earnings haven’t been revised down enough,” said Mr Wong. “If the markets don’t come off here, the price-to-earnings ratio is going to get even higher.”