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With stock indices trading at a price-earning only slightly in excess of the long-term average, it’s hard to argue that stocks in general are as over-valued as they were in the heydays of the ‘technology boom.’ However there are a few measures of valuation that are sticking out as being well above long-term averages. One is the ‘Shiller’ or ‘normalized’ level of earnings. This measure, developed by award-winning economist and professor, Gary Shilling, measures earnings on a longer-term ‘normalized basis. The Shiller P-E adjusts profit margins to be at the long-term average, thereby removing some of the cyclicality that comes with earnings margins, which reduces the volatility of the numbers somewhat. The chart below shows the Shiller P-E multiple over the last 100 years. While the absolute peak in valuations occurred during the technology boom of the late 1990’s (probably never to be seen again), the current level is well above the long-term average.
So we could definitely argue that stocks are expensive on this basis. Similarly the Market Value/GDP ratio (value of the stock market versus the total value of everything produced in the economy) is now at 118%. It has only been above 100% on two other occasions in the past twenty-five years and both preceded major market downturns. So some measures of valuation are certainly at the high end of their respective ranges
One big winner in the stock market recently has been Facebook. The company reported exceptionally strong 2nd quarter earnings, beating expectations for the 7th straight quarter and sending the stock to an all-time high, more than double the IPO (Initial Public Offering) price of just two years ago and over 4 times higher than the low seen in the stock six months after the IPO. Even before the recent earnings were released we saw data from Comscore that showed that the social media company’s market share of all time spent on the Internet was about 18% in June for desktops, and 20% for mobile devices, an absolutely staggering number for a single website. Acquisitions such as Instagram and Whatsapp have kept users online with the service while advertisers have been swarming to the site to access the active user base of over 800 million people. The main bearish argument on the stock is the valuation. The company’s market value is now over US$190 billion, a lofty valuation to say the least for a company that had revenue of US$2.9 billion and earnings of US$791 million last quarter. We still own the stock but have reduced the position on this recent strength. We still see the potential for a further 50% gain in the stock price but that would be a 4-year target price. In the meantime, better gains could be seen from Google in the search market. We also continue to hold Apple after strong recent results but reduced our position in Qualcomm, as its earnings look to be slowing down over the next few quarters as they deal with licence payment issues in China and more competition in their 4G/LTE chip business from Intel.
Canadian banks continue to lead the market higher, hitting new highs this year on strong earnings growth, healthy dividends and conservative business practices. While the banks have traditionally been the largest holdings of the Canadian institutional investor world, it was interesting to see that the largest net buyers of Canadian banks this year have been Goldman Sachs, Credit Suisse, ITG and Morgan Stanley!