Where the argument that current share market valuations are too high generally breaks down is that it is based on comparing current P/E ratios to very long-run historical averages. In this video and edited transcript below, Emma Davidson poses the question of whether valuations are too high to Miles Staude of the Global Value Fund.

When interest rates are high, P/E’s are low, as they were in the 70’s, and when interest rates are low, as they are today, P/E’s are high. That statement is a truism, pointing it out isn’t an argument that equities are overvalued.

Making a useful comparison

Comparing P/E ratios today, against the P/E ratios of, say, the 1970’s, with inflation and interest rates in the region of 15%, offers us no real insights into what is going on in the market today.

When interest rates are high, P/E’s are low, as they were in the 70’s, and when interest rates are low, as they are today, P/E’s are high. That statement is a truism, pointing it out isn’t an argument that equities are overvalued.

More importantly though, share markets price in future earnings expectations, not historical earnings. The global economy is currently in its best shape since before the financial crisis and that is flowing through into company’s earnings. The move we have seen in global share markets over the past 12 months has just followed increasing forward earnings estimates. Valuations, despite a 20% plus market rally are essentially unchanged, the forward P/E ratio for global shares markets is currently about 16x, which give or take is where it has been for several years now.

Shares still offer value

Relative to other asset classes, shares still look like good value, in fact you could even call them cheap. I know that might sound like a stretch to some people, but the earnings yield that shares offer today is far higher than the returns on offer from other major asset classes, like high-yield or corporate bonds, where yields, especially after accounting for inflation, have basically disappeared. Shares are riskier investments than bonds, and it is normal that they should offer a greater yield, but the difference between the two asset classes is now far greater than what it has been in the past. Shares are far better value than most other investment alternatives today.