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Is the World’s Largest Hedge Fund Right about Equity Valuations?

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Apr. 22 2019, Published 7:12 a.m. ET

Margins on the verge of reversion

In its research, Bridgewater Associates has argued that the current margins in the US corporate (DIA) (QQQ) sector aren’t sustainable. In fact, the factors that have been supporting higher margins for the last 25 years are on the verge of reversing.

Bridgewater has argued that while it’s difficult to assess which factors will weigh on profit margins and how much can be offset, it will be hard for companies to maintain their current margins—let alone increase them.

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Margin expansion has fueled the bull run

Margin expansion has been one of the drivers of the unprecedented bull run in the US equity markets (VOO). Companies’ first-quarter earnings results will be crucial to deciding the future course of the markets. In the first quarter of 2019, the S&P 500’s (SPY) earnings are expected to fall 4.3%, which will mark its first year-over-year earnings fall since the second quarter of 2016.

Overvalued equities

The valuation of equities has a lot to do with the margins companies are earning. If companies are able to maintain their current margins, and these can be extrapolated, then valuations are reasonable. If margins stagnate, then valuations are expensive, and if margins revert to their historical averages, then equities are highly overvalued.

Bridgewater’s analysis has shown that margins are expected to contract, implying that equities are currently overvalued.

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