Have stocks become too expensive?

The MSCI World achieved a return of almost 25% in 2019. In part, this was a compensation for the negative stock market in 2018. Nevertheless, the annual share growth of around 11% on average over the past three years is remarkably high for the nominal growth of 3.5% that the global economy experienced over the same period.

Prices have risen steadily, especially since last summer. Central banks had already pushed prices up considerably before the summer by providing additional stimulus. Especially the u-turn the U.S. Fed made helped the prices go up. After the summer, uncertainties the trade war between the US and China and Brexit caused, also disappeared. In addition, fears of recession faded because of improved confidence indicators and companies' sales figures were by no means disappointing.

The question is now whether shares have become too expensive. Overvaluation in itself does not cause a correction, it always happens due to new negative information or deteriorating expectations for the future. Current stock prices show how high this valuation has become over the past few months. Both the price/earnings ratio and the price/book value ratio are above their long-term average. Nevertheless, these ratios are not as high as before, for example at the end of 2017.

Expectations of future earnings have also been somewhat lowered. This is mainly due to the fact that the realised profit growth in 2019 was briefly negative. Expectations in this respect recovered as economic growth prospects improved. However, it can be questioned whether the expected profit growth of almost 9% for next year is not too high. The stock market already seems to be very much in anticipation of an upturn in economic growth.

Pieterse-Bloem sees a number of things that can either be good or bad. For example, profit growth can be better than expected due to stimulating measures by China and the major central banks. A big boost for the economy, and therefore also share prices, would be if governments would listen to the new president of the IMF and the ECB to increase public spending. On the other hand, future earnings growth will be disappointing if it turns out that it will take longer for the increased producer-confidence to translate into higher economic activity. 

Central banks do take action when growth is disappointing, but in the meantime the effect of their actions seems to diminish. The latest international incident, the dispute between the US and Iran, also shows that there is little room for bad news at these exchange rate highs.