Why Valuation Alone Won’t Save Equities

After the October selloff, stocks got cheaper. But that might not be enough for a continued rebound, Russ suggests.

The first 29 days of October put markets on track for their worst month since the financial crisis. Then the selling abruptly stopped and buyers rediscovered their animal spirits. Since Monday’s low, global equities have rallied close to 5%, erasing a significant portion of October’s plunge. Even more interesting, there has been no clear catalyst for the rally, leaving some to suggest that stocks were simply too cheap to ignore.

From my perspective, the rally of the last several days looks like a technical bounce, i.e. a short term exhaustion of selling, rather than bargain hunting. To be sure, there are pockets of the market—notably Japan and many emerging markets—that could be described as cheap. But at the broader level, and particularly in the United States, it is difficult to argue that stocks got so cheap buyers simply could not help themselves.

Developed market equities are trading close to their historical average, with the MSCI World Index currently at roughly 14 times forward earnings (see Chart 1). Looking at price-to-book (P/B) suggests the same conclusion. The MSCI World is trading at 2.25 times price-to-book (P/B), right around the long-term average.

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Looking at more recent data also suggests that valuations are close to the middle of the range. The P/B on the MSCI World Index is roughly 6% cheaper than was the case in late January. That said, stocks are about 10% pricier than two years ago, just prior to the post-election rally.