Vanguard Global Chief Economist Joseph Davis thinks there is a 50% chance of a correction in stock prices this year. The reason: equity valuations have become detached from economic reality.
“I just think that price appreciation is just moving well above fundamentals,” Davis said on Yahoo Finance’s The First Trade. “I still believes stocks outperform bonds over the next several years, but we have to have reasonable expectations. I think we are continuing to see a disconnect where prices exceed fundamentals, and that’s the reason we should be prepared for some downside risk to the equity market.”
Davis doesn’t see a bear market in stocks this year, but rather one of those healthy re-adjustments in equity valuations that entice buyers back into the mix. The observation by Davis on overheated valuations is not without merit though.
Shares of tech giant Apple have surged 102% in the past year, taking the price-to-earnings multiple to a rich (even for Apple) 21 times forward earnings estimates. Bank of America Global Research notes Apple’s stock (AAPL) trades at a “stretched” 40% above its 200-day moving average. Money-losing electric car maker Tesla (TSLA) has seen its market cap — at one point in January — exceed that of established automakers Ford (F) and General Motors (GM) combined.
Chipmaker Advanced Micro Device’s stock (AMD) has gone up pretty much in a straight line since October 2019 on minimal fresh news. The high-beta stock has skyrocketed 143% the past year — it trades on an inflated P/E of 44 times forward earnings.
These types of individual stock moves — or the one in the broader market — don’t appear to be justified when assessing the U.S. economy. The Labor Department reported Friday that non-farm payrolls rose 145,000 in December, missing consensus forecasts by 15,000. The year-over-year growth rate in average hourly earnings of 2.9% marked the slowest rate of growth since July 2018.
The lackluster December jobs report comes on the heels of persistently weak reads on the U.S. manufacturing sector. Capital expenditure spending by U.S. corporations also continues to be constrained on worries over U.S. trade conditions with China and the upcoming presidential election.
In the end, low interest rates by the Federal Reserve could only do so much to support stock prices. At some point, the economy will have to do its part to justify current stock valuations.