US Equity Markets. An unfair game?
Daniel Arsenault, Investment Director with the Mackenzie Ivy Team, suggests that US equity market valuations are more elevated than others, and the odds of a positive market move from here are not in the investor’s favour.
Normally betting games are terrible analogies for investing, but betting games and investing actually have one critical thing in common and that is that the expected payoffs need to be balanced against the odds of winning.
Now, everybody loves a market that goes up and if you’ve been invested in the U.S. stock market over the last 10 years, clearly you’ve been a winner.
On the Mackenzie Ivy team, we analyze historical data to determine the odds that U.S. equity markets will go up from here, and what are the potential outcomes if they do?
Our system looks at the price-to-sales ratio, which is one of the most reliable predictors of forward performance. The price-to-sales ratio is a number which relates the share price of a stock to the amount of revenue generated within that stock. The number gives us an indication of how much money investors are paying per dollar of revenue for every share they buy and then averages it up to the whole market.
A low ratio would indicate that stocks might be undervalued and undervalued stocks might be set to rise in the near term. Whereas a high ratio might indicate that stocks are actually overvalued and set up for a fall.
In the first quarter of this year, the price-to-sales ratio of the S&P 500 hit 2.14. Now that’s investors paying two dollars and fourteen cents for every one dollar of revenue generated within their stocks. That’s the highest number we’ve seen in almost 20 years, since right before the tech crisis.
If we go back 30 years, all the way back to January of 1990, we see that the price-to-sales ratio of the S&P 500 has only been higher than we are now about 5% of the time. When markets did move higher than where we are now, the return was only about 3% on average. So, we estimate that the odds of an upward move from here to be about one in 20, and the expected payoff, if markets do move up, to be less than 5%.
In our view, the odds are not in the investor’s favour and the expected payoffs do not compensate us for the risks. So where does this all leave us? On the Mackenzie Ivy team, we’re looking for high-quality companies and we’re looking to invest in them at attractive valuations and we’re looking everywhere in the world. Right now, Asia and Europe are lovely places to visit and even better places to invest. Both are offering better valuations than we see in the U.S. and therefore they’re offering better odds and payoff for investors.