Gauging the Current State of Value in the Markets
The E/P (Earnings/Price) valuation spread became particularly pronounced in 2018. The spread continued to widen and remains considerably elevated today. This valuation gap is consistent with what’s happened during other periods of tremendous market stress: Historically, the E/P spread has become very wide around extreme points in the market, most notably the Tech Bubble, Global Financial Crisis, and currently, the COVID-19 pandemic. This appears to be driven by investors paying up for expected growth in expensive stocks, especially in the Tech sector, similar to what we saw during the Tech Bubble. Additionally, investors appear to be shunning cheap stocks due to perceived risk, similar to what we saw during the Global Financial Crisis and at the onset of the COVID-19 pandemic. Our research shows that the valuation spread may help predict how value stocks will perform in the future. But first and foremost, it’s critical to define and understand the valuation spread in order to apply this analysis.
Why is the E/P spread still elevated?