Bear markets end typically end with less bad economic news than feared, or valuation support. Unfortunately, based on history, the U.S. market still isn’t seeing much valuation support.
The S&P 500 currently trades at a little over 20x current earnings, even after 2020’s price declines. That’s high in a historical context. Over a long span of history, the S&P 500 market has, on average, traded at around 15x earnings. Now, of course that’s an average, the markets have spent considerable time below that valuation as well as above it. Still, you’d expect the stock market to end a bear market below its historically average valuation.
So there’s little in the way of valuation support for markets today. Yes, valuations are less rich than they were, peaking at over 30x earnings, but the U.S. market could still have some way to fall on a historical basis.
Rising rates are another problem for market valuations. Though not directly comparable, it was argued that very low interest rates, such as 2% yields or less on the U.S. 10-year Treasury bond, meant that stock valuations could be justifiably higher. There’s some truth to that logic as stocks and bonds are substitute assets for investment, the flow of cheap money helped valuations of most assets.
However, the problem with this comparison is that yields have risen sharply in 2022. Money is no longer cheap. The 10-year yield currently stands at almost 4%. That’s a lot closer to its historical norm.
An important justification for why you might want to pay higher valuations for stocks, due to lower bond yields, just changed materially in 2022. So it’s unclear why U.S. stocks should trade at such a historically elevated valuation today. That potential issue becomes more apparent when you look overseas.
U.S. markets may have elevated valuations compared to history, but many other international markets are more reasonably valued. For example, data from Research Affiliates, has U.S. large caps more richly valued than all other markets except India.
Most other markets are currently trading below long-term average valuations today, the U.S. is one exception. That’s not encouraging, and may suggest that international markets will offer superior returns over the medium term. Germany, Japan and China all appear notably inexpensive currently, though stock markets in each country have specific issues.
Still, stock valuations are considered at best medium-term indicators of performance. Current data suggests that U.S. markets may offer a below average return on a 7-10 year view, even despite losses in 2022.
Such metrics are less helpful for short-term performance. Signs of improving economic news may well end the bear market well before valuation support changes the fortunes of the stock market.
Typical Bear Markets
Also, the typical bear market is around 10 months long, we’re currently 10 months into this bear market, so we may be closer to the end of this bear market at this point. The average loss in a bear market is 36%. We haven’t hit that yet, with markets currently off 20%, though the lows of 2022 have approached at 30% decline. So what we’ve seen in 2022 so far is almost exactly average for a bear market.
If this bear market does end with attractive valuations compared to history, the U.S. market still has some way to fall. However, it may be that signs of improving economic news, changes the fortunes of U.S. stocks in 2023. Even so, despite recent declines, international markets appear a lot more attractive in valuation terms than the U.S. does today.