Are US Stocks Heading for a Fall?

It’s a truism that what goes up, must come down—but when, and by how much? That matters, especially if you’re talking about the US stock market.

With the S&P 500 approaching the 2000 mark and nearly three times its low point in early 2009, market pundits have started to say a correction is overdue. After all, as many note, the S&P 500 is selling at about 15.6 times consensus estimates of forward earnings—slightly higher than before the 2008 crash.

Clearly, US market valuations are well above their long-term average, as the left side of the Display, below, shows. Non-US stocks, both developed and emerging, are more attractively valued, based on their price-to-forward earnings. But we think that US companies today deserve some premium (compared to both their own history and to non-US companies) because their fundamentals are so strong: US companies are generating unusually high earnings, carrying much less debt, and returning more cash to shareholders via dividends and share buy-backs. Sometimes, you get what you pay for.

Stocks Are Fairly Valued and Attractive Compared to Bonds

And relative to bonds with their ultra-low yields, all major stock indexes look decidedly attractive now, as the right side of the display shows. Comparing stocks to bonds is important: Where can investors go if they pull (or stay) out of stocks?

History suggests that market valuation tells us little about near-term market direction. The left side of the second display, below, portrays one-year returns for the S&P 500, arrayed by the price-to-forward earnings at the beginning of each period. When the market has previously been close to its current valuation, there has been a very wide range of returns in the subsequent year. That was also true when valuations were lower or higher. Basically, stocks can be very volatile in the short run, and the market could rise or fall significantly over the next year regardless of its valuation.

Stocks Headed for a Fall

If you extend your time frame, however, the behavior of the market looks much more predictable. The right side of the display shows that with a five-year horizon, the range of market returns has been narrower. Furthermore, valuation has mattered over longer horizons: when the price-to-forward earnings has exceeded 20, the subsequent five-year S&P 500 return has, in most cases, been low or negative.

What does this mean for investors? We think that current stock market valuations are not a clear signal of what will happen in the next year or two. Stocks could drop, and if they did, we’d likely see it as a buying opportunity. Or the market could soar, possibly to a point where we would recommend paring back. But, most likely, we’ll see modest returns in the next few years.

Past performance does not guarantee future returns. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio management teams.

Seth Masters

Chief Investment Officer—Bernstein
Seth Masters is Chief Investment Officer of Bernstein. He heads the team that provides customized wealth-planning advice and manages the firm’s private client portfolios. Masters was previously CIO for Asset Allocation, overseeing the firm’s Dynamic Asset Allocation, Target Date, Target Risk and Indexed services. In June 2008, he was appointed head of AllianceBernstein’s newly formed Defined Contribution business unit, which has since become an industry leader in custom target-date and lifetime income portfolios. Masters became CIO of Blend Strategies in 2002 and launched a range of style-blended services. From 1994 to 2002, he was CIO of Emerging Markets Value Equities. He joined Bernstein in 1991 as a research analyst covering global financial firms. Masters has frequently been cited in print and appeared on television programs dealing with investment strategy. He has published numerous articles, including “The Case for the 20,000 Dow”; “Long-Horizon Investment Planning in Globally Integrated Capital Markets”; “Is There a Better Way to Rebalance?”; and “The Future of Defined Contribution Plans.” Masters worked as a senior associate at Booz, Allen & Hamilton from 1986 to 1990 and taught economics in China from 1983 to 1985. He holds an AB from Princeton University and an MPhil in economics from Oxford University. He is fluent in French and Mandarin Chinese. Location: New York

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