Stock Valuations Plunge To Lowest In 5 Years

Plunging U.S. and global stocks have left valuations at their cheapest levels in nearly a half decade. In America, stocks' forward price to earnings ratio has fallen from around 16 to 13.3, a pretty hefty drop, or 17.7% cheaper than five years ago. Meanwhile, the valuations of stocks in Asia have fallen 18%, in Europe by nearly 19% and in China by 28%. Using another metric, price-to-free cash flow, stocks are the cheapest they've been since early 2012, per the Wall Street Journal.

A partial explanation for falling valuations is that rising bond yields have made ultrasafe government bonds more attractive than before, leading conservative investors to diversify away from equities. Other factors such as trade tensions, geopolitical uncertainty, tightening monetary policy and concerns about regulation of once hot industries like tech have taken their toll on global markets.

Bargain Hunters Avoid U.S. Stocks

While this trend is welcomed by many value investors, U.S. stocks remain more expensive than foreign equities. And that's leading many investors to look elsewhere for bargains. “I am more constructive on the prospects for European, U.K., and Asian markets over the next few years in regard to their ability to generate returns,” says Nick Mustoe, chief investment officer at Invesco.

Todays' U.S. valuations may seem rich given the uncertain outlook for earnings. FactSet consensus estimates of 15.9% U.S. earnings growth in the next 12 months could come down sharply as investors gear their forecasts to slower economic growth, potentially pulling stocks down further. 

As outlined in detail per an earlier Investopedia report, investors would still do well to prepare for the possibility of more downdrafts in stock prices. While the S&P 500 is roughly flat year-to-date through Wednesday morning, the ten-year bull market nearly quadrupled U.S. stock prices. Nobel Laureate in economics Robert Shiller, the developer of the CAPE ratio, has continued to warn that current market valuations are unsustainable, and that the “US stock market is the most expensive in the world” based on his analysis. If investors start to grow skeptical about robust earnings forecasts, stock declines may be dramatic, Shiller says.

Investopedia also outlined a report by Goldman that looked at nine valuation metrics for the S&P 500 Index and found that the values for seven of them are significantly above historic averages for the period since 1976.

More Pain Ahead

Ultimately, the fact that U.S. valuations remains high versus global peers indicates that the great U.S. bull market may face more jarring pullbacks as it downshifts. Major stock markets in China, Germany Korea, Mexico and elsewhere have already slipped into bears, leaving a growing number of market watchers to suggest that the U.S. may be up next.