(Source: Momentum Global Investment Management)
19 July 2020
Source: Bloomberg & Momentum Global Investment Management
What this chart shows:
This chart shows the relationship between US equity market valuations and forward returns. Specifically, we show the S&P 500 forward P/E ratio - the ratio of current price to forward 12 month expected earnings – and forward annualised returns over the period from 1990-2020 using monthly data. The blue dots show the relationship between starting forward P/E and forward 10 year annualised total returns. The grey dots show the relationship between starting forward P/E and forward 1 year total returns. The vertical line shows the current valuation of the S&P 500 as at last month end (forward P/E ratio of 24.9).
Why this chart is relevant:
The graph illustrates a negative relationship between the starting forward P/E ratio and forward 10 year returns, showing that low valuations typically result in higher longer term returns, whilst high valuations have historically led to lower longer term returns. History tells us not to expect high 10 year returns from here, based on current valuations. However, the grey dots show that good returns can still be made over the short term following high starting valuations. It is worthwhile looking back to identify when those periods occurred in the past. Interestingly, they exclusively occurred during the rally in stock prices at the time of the tech bubble in the late 1990s and early 2000s, suggesting an element of investors chasing returns or a FOMO (fear of missing out) mentality, arguably behaviors we witness today.
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