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It’s All Relative: Why Stocks May Not Be Overvalued

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RANDY FREDERICK: 2017 has been a great year for investors, and not just in the United States, but also globally. Jeff Kleintop joins me for the December 4th Schwab Market Snapshot, to give us his take on whether or not valuations have gotten a little too high, or if there are still opportunities out there.

So, Jeff, stocks have gone up, literally, every month this year, and part of the reason is because we’re experiencing one of the broadest periods of global economic growth in a decade. So my question is, have stocks built-in all the good news, or is there still time left to buy?

JEFF KLEINTOP: Well, Randy, valuations are above average, and valuations are very important to long-term returns, as we know, but, interestingly, there’s been no consistent relationship between the price-to-earnings ratio currently and what returns are over the next 12 months. That may surprise a lot of people.

In fact, since the inception of the MSCI World Index—that was back in 1969—when we have PEs in the range of where they are now--right now about 21.3 on that MSCI World Index--anytime they’ve been plus or minus half-a-point of that, returns have averaged over the next 12 months, anywhere from negative 5% to positive 45%. So, it’s a pretty wide range, and the average has been plus 17-1/2%, so there’s no reason based purely on valuation why stocks couldn’t go higher over the course of the next year, despite above-average valuations.

RANDY: Okay, so if, on a global basis, stock markets aren’t too high that they couldn’t still go higher still, there must be some differences, because there are a lot of different countries and a lot of different markets. So which ones are relatively expensive compared to some of the others?

JEFF: Yeah, it’s a great question. Global growth has been great, which explains above average valuations everywhere, but some markets are more expensive than others. For example, the US currently has a PE of around 25 times earnings, and that’s for the MSCI USA Index, and that’s above the MSCI Euro Index, which tracks the 19 Eurozone countries, and that has a PE of 18 right now.

And then Japan, the MSCI Japan Index has a PE of 15. So the US looks expensive versus Europe or Japan, but it’s not quite that easy, as you know, Randy. The truth is that each of these markets, we believe, is fairly valued relative to how it performs. Let me show you what I mean.

So the US tends to very closely track tech stocks, and the US index, the MSCI USA Index, has a PE very similar to the MSCI World Information Technology Index. They both track each other. Both have a PE of around 24-25 times earnings.

Europe, 19 different countries make up the MSCI Euro Index, or the Eurozone, and the MSCI Euro Index tends to move like three different sectors—financials, materials, and telecom. If we blend those three together, a PE of 18, just the like the MSCI Euro Index.

And, finally, Japan very closely tracks the financial sector, and the World Financial Index right now has a PE of 15, just like Japan.

So all these markets are valued the way they perform, and so I think they’re valued fairly. Obviously, differently from each other, but the sectors tend to behave differently.

And so from that perspective--you know, all it suggests is that relative valuations don’t currently favor one country or region over another, and it makes sense to be globally diversified right now across borders in line with strategic weightings. And that means that your international weighting should broadly correspond to what you see in those major global indexes.

RANDY: Thank you so much, Jeff. That sounds like a really smart way to compare stocks among different countries.

Listen, if you want to read more from Jeff, you can do that in the Insights & Ideas section of Schwab.com. You can follow Jeff on Twitter @JeffreyKleintop, and, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.

Definitions

P/E ratio (price/earnings ratio) is a measurement that represents the relationship between the price of a company’s stock and its earnings for the past year. To get a company’s P/E ratio, divide its current price by its earnings per share (EPS) for the past year.

The MSCI World Index captures large and mid-cap representation across 23 Developed Markets (DM) countries*. With 1,634 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI World Financials Index is designed to capture the large and mid-cap segments across 23 Developed Markets (DM) countries. All securities in the index are classified in the Financials sector as per the Global Industry Classification Standard (GICS®).

The MSCI World Information Technology Index is designed to capture the large and mid-cap segments across 23 Developed Markets (DM) countries. All securities in the index are classified in the Information Technology sector as per the Global Industry Classification Standard (GICS®).

The MSCI World Materials Index is designed to capture the large and mid-cap segments across 23 Developed Markets (DM) countries. All securities in the index are classified in the Materials sector as per the Global Industry Classification Standard (GICS®).

The MSCI World Telecommunication Services Index is designed to capture the large and mid-cap segments across 23 Developed Markets (DM) countries*. All securities in the index are classified in the Telecommunication Services sector as per the Global Industry Classification Standard (GICS®).

The MSCI Euro Index captures large cap representation across the 10 Developed Markets (DM) countries in the EMU*. With 124 constituents, the index covers approximately 70% of the free float-adjusted market capitalization of the EMU.

The MSCI USA Index is designed to measure the performance of the large and mid-cap segments of the US market. With 622 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.

The MSCI Japan Index is designed to measure the performance of the large and mid-cap segments of the Japanese markets. With 314 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.

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