Had you blinked year to date and just opened your eyes, you could think that stocks moved very little in 2016– U.S. stocks are almost even with where they started the year. But that would be glossing over the worst-ever start to the year for U.S. stocks and weeks of blind panic around the world.
At their worst point, U.S. stocks were down 10% this year. Now they’ve returned to just about flat. What’s more, the assets that were scariest a month ago are doing surprisingly well. Energy is up 3.4% on a total return basis (which includes dividends). Materials are up 3%. The MSCI emerging markets index is up 3.7%. The Market Vectors Gold Miners Index ETF (GDX), long left for dead, is up 39%. And in case you really did blink, crude oil has rallied 45% from its low.
We’re not even through the first quarter of the year yet. That’s how fast things can snap back.
Looking back to the beginning of the year, it’s true that things looked bad. The problems were real, and you could focus on them or not. But as my colleague Eric Hanson recently wrote, “The sum total is that investors went from seeing the world as a glass half full to a glass half empty.”
Now that we’re suddenly back to the glass half full, we must wonder whether we are seeing things more clearly now than we did in February. Did we push stock prices too low in February and suddenly return to our senses in March? Or are we deluding ourselves now and pushing stock prices too high? Just where are stock valuations?
Research firm Morningstar sees stocks as fairly valued now – though they’ve only just become so after being undervalued for most of 2016. Last week, its market price-to-fair-value ratio was 0.98 (1.0 would mean stocks are priced exactly at fair value). At the trough of undervaluation on February 11, that number was 0.86. Things have turned around so quickly the last month that energy and materials have gone from being undervalued to overvalued. For Morningstar, financial services and health care are now the only undervalued sectors.
In contrast, Warren Buffett’s favorite measure of overall stock market valuation – total stock market capitalization value versus GDP — indicates that stocks are significantly overvalued. Today the market cap/ GDP ratio in the U.S. is at 116. During the 2009 financial crisis, that number was as low as 57. At the height of the internet boom in 2000, it was 149.U.S. Market
Total U.S. Stock Market Capitalization/ U.S. GDP
And Jeff Gundlach of DoubleLine, among others, sees extreme overvaluation. He recently said stocks are so unattractively priced that investors could expect returns of only 2% to a loss of -20%.
We are not so pessimistic, but it does seem that at the least, fair to expensive markets are the order of the day. In any case, few are banging the table to proclaim that U.S. markets are undervalued – and this rings true to our experience. We are seeing both pockets of undervaluation and bizarrely persistent overvaluation as we look at specific securities. Compared to a month ago, we are being forced to look harder for opportunity.