April 2, 2014

LPL’s Kleintop: Is the Party Over in Stocks?

The chief market strategist checks in on what bubbly valuations mean for equity investors and their advisors

Consumer confidence is at six-year highs, and investors are feeling pretty good, too. But does that mean there’s a bubble in the stock market?
LPL Financial (LPLA) chief market strategist Jeffrey Kleintop tackles that question in a report released Wednesday. He zooms in on the price-to-earnings ratios of 62 industries today versus 14 years ago, at the top of a bull market.
“The stock market was really ‘bubbly’ in March 2000,” Kleintop writes, “with valuations of many industries floating higher, but now industry valuations are relatively flat.”
In late March 2000 — the tech-bubble era — 16 of 62 industries accounted for about 70% of the S&P 500’s total market value and had P/E ratios that could be called “bubbly,” i.e., more than 30.
Fourteen years later, only four industries out of 62 — accounting for less than 4% of the S&P 500’s current market value — have P/E ratios over 30, the strategist points out.

While in 2000, IT firms and industries were overvalued, today’s high P/E ratios can be found in real estate/REITs, health care technology, Internet and catalog retail, as well as in construction materials.
“At any given time, there are always some bubbly valuations among industries and stocks that are hot,” explained Kleintop. “But overall, the S&P 500 PE is currently a bit over 16 on current fiscal year estimates, slightly above the long-term average, but only half of what it was in late March 2000.”
Thus, his conclusion is that today’s stock-market party “is not yet close to being over.”
Still, many factors can bring on a bear market, as the financial crisis of 2008-'09 showed.
As for general expectations, Kleintop says the markets are optimistic when it comes to improving economic growth, but they “do not appear to be pricing in an overly optimistic outlook.”
And when it comes to consumer confidence, he says, the index is at 92. That’s well below the 100 it averaged in 2005–'07, and “a far cry from the 140 averaged in 1998–2000, when the party was really heating up and valuations became ‘bubbly’ across most of the stock market.”
Valuation Variations
“Although valuation may not be a negative for the overall stock market, it is no longer a positive,” Kleintop explained, namely due to the strong gains over the past year.
As a result, investors should expect more market pullbacks — or market storms — this year, he notes.
As for the risk of a bear market, the LPL strategy group does not believe valuations “are high enough to result in a long painful hangover. Instead, we continue to foresee a potentially solid year for stock market performance.”