uploads///CAPE ratio

The Recent Selloff Has Returned Value to Equities



Assuming the global economy continues to expand, the recent selloff has returned some value to many financial assets. Though stocks pared some losses by midday Monday, valuations for most assets are a long way from the tops typically seen prior to bear markets, according to my analysis using Bloomberg data.

Developed market stocks, as measured by the MSCI World Index, are now trading at roughly 2x book value, about 10% below their 20-year average and roughly 25% below their peak valuation in 2007. One example of a developed market region that has been particularly hard hit, probably excessively, is Europe. European equities, as represented by the S&P Europe 350 Index, are now trading at less than 12x forward earnings and 1.3x book value. The selling may be overdone, considering that investors may be exaggerating Europe’s exposure to China.

recent selloff

Article continues below advertisement

Market Realist – Though the recent selloff caused panic among investors, there was one positive side effect. Valuations—which had been rising—are now back in their historical average territory, opening up buying opportunities for investors. The graph above depicts Robert Shiller’s cyclically adjusted price-to-earnings ratio (or CAPE ratio). The CAPE ratio is defined as the price of a share divided by the ten-year moving average of its earnings. This ratio is used to assess valuations in markets. As you can see above, the CAPE ratio has plummeted to ~25x on account of the recent selloff.

recent selloff

Though the recent selloff was followed by a modest rally, there’s no doubt about the fact that valuations look slightly better than before. With the trailing-12-months price-to-earnings ratio dropping to ~17x last week, valuations seem to be skirting long-term average levels—a fact that both Citibank and Deutsche Bank have reiterated in their recent insights.

According to a recent post by Kevin Mahn in Forbes, the bull market still has some legs. As Mahn observes, the historical average price-to-earnings multiple for the S&P 500 (VOO) between December 31, 1990, and August 28, 2015, is 19.72x. The current market, particularly after the recent selloff, is still some ways off from that point, as you can see in the graph above.

Value investors can seek opportunities in sectors like financials (XLF) and technology (XLK). Both these sectors look attractive compared to the broad market. Both the financials (IYF) and technology (IYW) sectors tend to perform well even in rate-hiking cycles, and they benefit from an expanding economy.


More From Market Realist