Why you should be wary of "expensive defensives"

Time for caution, at least as regards North American stocks. Robert Shiller’s cyclically adjusted (ie, ten-year smoothed) p/e ratio for the US market now stands at more than 27 times the historic trend in earnings – significantly higher than on Black Monday 1987, and just a shade away from Black Tuesday of 1929 (whereafter the US stockmarket fell, peak to trough, by some 89%). Just as ominously, the average for the Shiller p/e is just 16 times.

However you look at it, US large-cap stocks are expensive. On the basis of forward-looking earnings rather than historic ones, the S&P 500 share index currently trades on a prospective p/e of 18, according to Bloomberg. That puts US stocks at their most expensive since 2002.

John Authers for the Financial Times points out that corporate earnings in North America have now declined for four consecutive quarters: “Historically, earnings declines this protracted are always accompanied by equity bear markets.”

There are other reasons for caution. The US rally has been driven in large part by stock buybacks – many companies have been borrowing money just so they can buy back their stock. If companies are buying back their stock when it trades below book value, fair enough; that is value-enhancing for shareholders. But if they’re buying back stock at a significant premium above fair value, they are destroying shareholders’ capital. In any case, buybacks are now falling, which suggests that the future prospects for the US market are not as promising as they have been.

Other grounds for concern: investors have been favouring high dividend-paying stocks for some time, given the lack of yield available to bondholders. This has made many yieldy stocks “expensive defensives” as bond proxies. But the S&P 500 Dividend Aristocrats Index has now started to lag behind the broader market, suggesting that a change in tone, and perhaps overall market direction, may be on the cards.


Category: Market updates

From time to time we may tell you about regulated products issued by Southbank Investment Research Limited. With these products your capital is at risk. You can lose some or all of your investment, so never risk more than you can afford to lose. Seek independent advice if you are unsure of the suitability of any investment. Southbank Investment Research Limited is authorised and regulated by the Financial Conduct Authority. FCA No 706697. https://register.fca.org.uk/.

© 2021 Southbank Investment Research Ltd. Registered in England and Wales No 9539630. VAT No GB629 7287 94.
Registered Office: 2nd Floor, Crowne House, 56-58 Southwark Street, London, SE1 1UN.

Terms and conditions | Privacy Policy | Cookie Policy | FAQ | Contact Us | Top ↑