Gauging the Gold Impact: Can Earnings Catch up with Equity Valuations?
Equity markets: higher highs
After slipping somewhat in the beginning of September 2017 amid geopolitical concerns, US equity markets (SPY) (SPX) (DIA) (DOW) have rebounded once again. Risk-appetites returned to the market, pushing the S&P 500 to an all-time high this year.
But the higher highs in equity markets have left investors wondering how long this bull market can sustain, and the trend is making market participants more nervous about a potential correction. The question that immediately comes to mind is if, in such a situation, the valuations of the equity markets have become overstretched.
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Lofty equity valuations
Based on historical standards, valuations remain quite high, driven by an expansion in profit margins for stocks. Further gains, however, would need to see earnings grow at a much steeper rate.
According to the GMO (Grantham Mayo Van Oterloo & Company) strategist James Montier, either dividends and earnings will need to start growing at a faster pace, or valuation multiples or margins will need to expand more to justify future gains. Montier noted that margins and multiples have the tendency to revert to the mean, and so for investors to still keep on buying US equities, they must believe that “it’s different this time.”
Montier is not alone in voicing concerns about US markets getting overheated. Goldman Sachs (GS) also believes that equity markets look overvalued on almost every metric.
Equity market concerns and gold
Market participants are also concerned about the flagging economic reforms and infrastructure agenda measures of the Trump administration. One of the factors supporting higher valuations appears to be higher corporate earnings growth, but if this disappoints as well, markets might be in for a correction.
If such a correction happens, vigilant investors will be diversified in order to minimize the potential risk, and gold tends to provide a viable alternative as it offers returns through capital appreciation and can provide capital safety in the face of geopolitical turmoil.
Gold price strength also favors miners such as Gold Fields (GFI), Barrick Gold (ABX), Kinross Gold (KGC), and Coeur Mining (CDE), which are leveraged plays on gold (JNUG). These stocks can appreciate more than gold prices in the event of an upturn.