Bob Homan: Between hope and acrophobia

May 7, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Bob Homan, Head of ING Investment Office

After a spectacular climb, some investors look down into the valley with fear, afraid of falling back from a great height. Fortunately, phobias are imaginary and the famous Shiller PE ratio is not all that it seems.

If stock markets rise fast enough and break record after record, doubts automatically arise about future price gains. After all, what is added in return today will not be added tomorrow. Even now, after a period in which a lot of good news has been discounted in the prices, the question arises whether they have not risen too high. And so the Price Earnings (PE) ratio of the American economist Robert J. Shiller appears again here and there in analyses. To smooth out any cyclical movements, this valuation methodology looks at the price/earnings ratio based on profits over the past ten years.

PE ratio at a historically high level

And what do we see? The Shiller PE ratio for the S&P 500 index is above 30. That's not bad, because there have been few times in history when the index (by this standard) was more expensive. If the development continues, from this level onwards a period with below-average returns will usually follow. But before you immediately get rid of all your effects: the question remains whether it will work out the same this time.

Megacaps are very profitable

It could well be that corporate profits will fall much less rapidly in a coming downward cycle than in previous cycles. It's like this: the current high profits of the megacaps, which are currently benefiting most from the burgeoning development and implementation of artificial intelligence (and will continue to do so in the near future), may well be permanent.

A second reason that it is different this time has to do with the same Shiller-PE. For the rest of the world outside the US – such as Europe, Japan and the emerging markets – that ratio is not that high at all and therefore predicts approximately average returns for the coming years. It is difficult or impossible to imagine that other blocks are doing well, while the American stock markets are doing poorly.

The rest of the world is catching on

What it actually comes down to is that the future is not determined by one factor. Many things play a role in determining future stock market returns. After a long period in which the American stock markets strongly outperformed everyone, the rest of the world may do better in the near future. As a result, the various Shiller PE ratios become more in balance with each other. Moreover, the US PE ratio will naturally fall if price increases lag behind the assumed cycle-resistant earnings growth. There are plenty of reasons for hope and less for fear of heights.

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