The recent uptick in valuations comes as stocks rise, albeit mildly, to a fresh record high in nearly every session. And while the P/E numerator is rising, the denominator is falling, as the recent crush in crude oil prices is causing analysts to meaningfully reduce their profit projections for energy-exposed stocks.
Back on Sept. 30, analysts were looking for the energy sector to show earnings growth of 7.8 percent in 2015. Analysts are now looking for a 1.4 percent decline in profits. That huge reduction has helped bring the overall growth-rate projection for S&P 500 earnings down from 11.8 percent to 9.7 percent, according to FactSet's senior earnings analyst, John Butters. The market's P/E ratio has risen accordingly.
The question now is whether investors should become nervous. After all, with the benefit of hindsight, we now know that nervousness was certainly warranted back in mid-2007.
"Absolutely you should be nervous," opined Jim Iuorio of TJM Institutional Services. "Whether you're looking at a five-year or two-month chart, you can see that we've pretty much been on a one-way street. Do I think price-to-earnings multiples are the be-all and end-all and we should just trade on that? No. And I think that you should still be bullish. But I think you should be bullish in a smart way."
On the whole, the market certainly does not seem too concerned about valuations. Fund flows continue to be strong, with $29 billion flowing into stock mutual fund and ETFs in the two weeks ended Nov. 12, according to Bank of America Merrill Lynch. And after spiking in mid-October as the market plunged, the CBOE Volatility Index is back to historically levels—which shows that investors aren't too interested in betting on, or insuring against, large downside moves.
Indeed, according to a Tuesday note from Simon Maughan of OTAS Technologies, while valuation metrics point to a short-term peak, "implied volatility continues to tick down. ... At the moment we are watching for a trigger for another downturn, but have not seen one."
"The doomsayers will be right at some point, but implied volatility isn't telling me that it's going to be any time in the next three months," Maughan added in an interview.
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Still, some say it's time to reassess portfolios, and perhaps take a step back from overly bullish strategies.
With valuations much higher than they've been of late, "I don't think being in stocks is the slam-dunk it was a couple of years ago. So we're being more cautious in equity allocation, trying to emphasize quality and stability rather than just growth and a rebound off the bottom," said Curtis Holden, senior investment officer at Tanglewood Wealth Management, a Houston-based firm that manages $830 million in client assets.
"One part of the market that has looked expensive has been small-cap stocks, so we're positioning our portfolios toward larger caps, toward the higher-quality part of the spectrum," he said.
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