Equity markets around the world may have rallied by 40 percent off their September 2011 lows, but they've got about another 13 percent to go by the end of 2014, according to Citigroup.
"Global equities aren't as cheap as they were in 2011, but that doesn't mean that they are yet especially expensive," Citigroup said in a report, noting most of its strategists are setting end-2014 targets forecasting double-digit returns from here.
In 2011, equities traded at 12 times historical earnings per share (EPS), Citigroup said, but while they now trade at 17 times, EPS has been flat. This indicates that the gains have been driven by re-rating, whereby stocks trade at higher valuations, the bank said.
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But it noted that even with the gains, valuations are still in line with the longer-term median. The cyclically adjusted price-to-earnings ratio, or CAPE, is at 20 times, compared with the long-run median of 24 times as well as the 30 times in 2007, it said.
"We find this reassuring," it said. "We are also reassured that equities continue to look cheap against fixed income," it said, noting the MSCI AC World Index trades on a dividend yield of 2.5 percent, in line with U.S. Treasurys.
But it added, "it seems unlikely that future gains will be totally driven by re-rating. We now need to see some EPS delivery. Fortunately, that is what we are now forecasting." Citigroup is forecasting global EPS to grow around 7 percent in 2013 and by a similar amount in 2014.
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"A resumption of global EPS growth would imply that re-rating will do less of the work from here," it said, expecting about half of equities' gains will be driven by EPS increases and half by re-rating.
"We can't be as bullish as we were a year ago, but we think it is still too early to turn bearish on global equities," it said.
For a value investor, Citigroup said valuations favor emerging markets and the U.K. over Australia, Japan and the U.S. as they are the most expensive regions. Among sectors, IT, financials and energy are the cheapest, while health care, materials and consumer staples look expensive, it added.
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However, Citigroup advised an approach balancing value and growth strategies, considering not just price-to-earnings ratios, but also EPS growth, which would favor emerging markets, Japan and Europe over the U.S. and Australia.
It prefers cyclicals over defensive stocks, picking consumer discretionary, materials, financials and industrials over consumer staples, telcos, healthcare and energy.
— By CNBC's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1