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Stock Valuations Improve on Lower Rates

Our bond/stock asset-allocation model indicates that bonds remain the asset class offering the most value. But stock valuations are much improved, in response to the decline in the benchmark 10-year government bond yield. Our model takes into account current levels and forecasts of short- and long-term government and corporate fixed-income yields, inflation, stock prices, GDP, and corporate earnings, among other factors. The output is expressed in terms of standard deviations to the mean, or sigma. The mean reading from the model, going back to 1960, is a modest premium for stocks, of 0.16 sigma, with a standard deviation of 1.0. The current valuation level is a 0.22 sigma premium for stocks, not far from fair value and down from a 0.98 sigma premium two months ago. Other valuation measures also show reasonable multiples for stocks. The current forward P/E ratio for the S&P 500 is 17.1, within the normal range of 10-21 and down from 22 a year ago. The current S&P 500 dividend yield of 1.6%, while below the historical average of 2.9%, is up from an ultralow 1.2% as recently as 2021. We expect results from our valuation model to continue to improve, as interest rates decline into next year and EPS growth picks up. Based on the current valuation levels, as well as interest rate and earnings forecasts, we called for a recovery in stock prices in 2023 from bear-market lows and in July set a year-end 2023 S&P 500 target of 4,600. That still holds. Our recommended asset-allocation model for moderate accounts is 67% growth assets, including 65% equities and 2% alternatives; and 33% fixed income, with a focus on core and opportunistic segments of the bond market. On duration, we recommend the short end of the curve. ...  The mean reading from the model, going back to 1960, is a modest premium for stocks, of 0.16 sigma, with a standard deviation of 1.0. The current valuation level is a 0.22 sigma premium for stocks, not far from fair value and down from a 0.98 sigma premium two months ago. Other valuation measures also show reasonable multiples for stocks. The current forward P/E ratio for the S&P 500 is 17.1, within the normal range of 10-21 and down from 22 a year ago. The current S&P 500 dividend yield of 1.6%, while below the historical average of 2.9%, is up from an ultralow 1.2% as recently as 2021. We expect results from our valuation model to continue to improve, as interest rates decline into next year and EPS growth picks up. Based on the current valuation levels, as well as interest rate and earnings forecasts, we called for a recovery in stock prices in 2023 from bear-market lows and in July set a year-end 2023 S&P 500 target of 4,600. That still holds. Our recommended asset-allocation model for moderate accounts is 67% growth assets, including 65% equities and 2% alternatives; and 33% fixed income, with a focus on core and opportunistic segments of the bond market. On duration, we recommend the short end of the curve.   more

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