US markets look pricey when we compare market capitalization to GDP. Why is the market ignoring this?
The S&P 500 is trading on a reasonable forward Price-Earnings Ratio (PE) of 15.17, but this forecasts a 23% jump in earnings over the next 12 months. Current as reported PE of 18.64 also assumes strong earnings growth.
Margins are growing:
But sales growth close to zero warns that earnings may falter:
Book value is surprisingly growing faster than sales, suggesting that corporations are hoarding assets rather than distributing profits to shareholders:
Causing asset turnover (sales/book value) to fall:
Which is why the valuation metric of Price to Book Value remains within reasonable bounds:
If management are unable to improve asset turnover — through improved sales or new investment — stockholders will start clamoring for higher distributions. Which may be one reason for high stock prices.
The second reason is that, with interest rates, tax rates and real wages at historic lows, corporations are likely to make fat profits over the next few years and stocks remain reasonably buoyant. But at least one of these factors can be expected to change in the next decade: recovery of the housing market would cause the Fed to lift interest rates; a revision of the tax code by a President who can work with both sides of the House; or a dramatic fall in exchange rates placing upward pressure on (real) wages as manufacturers regain export markets. The impact of any change will depend on how well the economy has recovered.
I will be watching sales growth, profit margins and asset turnover with interest over the next few quarters to see how this plays out.
Interesting here for me is the PE and EPS/Sales. Margins are at a cyclical high (boosted by QE?) so its the E that is questionable (highlighted by variation between 1yrPE and 10yrPE). Despite the Feds action margins will eventually contract. The 10yrPE is telling us that it will hurt.