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I hope you had a great weekend! Welcome to National Sock Day. Different from National No Sock Day, National Odd Sock Day and National Lost Sock Day (which recognizes all socks tragically lost in the evil dryer), this national holiday celebrates the continued pairing of all types of socks (it is an inclusive national day).

LRPC’s Monday Morning Minute for this week, “Are Stocks Too Expensive?” (presented below) comes to you courtesy of Charles Schwab & Co. As an independent, objective Registered Investment Advisory (RIA) firm, Lawton Retirement Plan Consultants, LLC (LRPC) has access to research from many sources. Be assured that I will share enlightening, useful information with you each week.

The market has been consistently rising throughout this year. Is it too late to buy into stocks? See what the experts from Schwab think below.

Have a wonderful week!

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Are Stocks Too Expensive?

 

By Jeffrey Kleintop, Charles Schwab & Co.

Key points

  • Although world stock market valuations are above average, similar valuations have produced double-digit gains over the following 12 months during the past 50 years.
  • Relative valuations do not currently favor one country or region’s stock market over another.
  • Valuations support a globally diversified portfolio offering the best diversification benefits in 20 years.

Stocks are up every month this year supported by the broadest economic growth in a decade. This is great news. But, have stocks already priced in all that good news? Is it too late to buy? Are stocks expensive?

Are stocks expensive? Maybe too expensive to buy?

History says no. While valuation is important to long-term returns, there has been no consistent relationship between the price-to-earnings (PE) ratio (the price per share divided by the last 12 months of earnings per share) and stock market return over the next year.

The current MSCI World Index PE ratio is 21.3. Since the inception of the MSCI World Index in 1969, a PE in the range of +/- 0.5 around 21.3 (20.8 to 21.8) has been followed by a total return of -5% to +45%, with an average return of +17.5%. Though valuations are above average — reflecting the better than average economic and earnings environment, there is no reason to believe stocks couldn’t go higher over the next year and even produce double-digit gains based on nearly 50 years of history, although of course history is no guarantee of future performance.

Are some markets expensive?

The global stock market may not be too expensive to rise, but what about the markets of different countries or regions — are some too expensive relative to others?

The U.S. has one of the highest PE ratios among countries or regions right now. Compared with the MSCI Euro Index, which tracks stocks in the 19 Eurozone countries, with a PE of 18, the U.S. looks pricey. Japan, at a PE of 15, looks like a real bargain.

Should investors favor Japan over the U.S. and Europe because it has a lower PE? We believe the answer is no, as all three of these markets are fairly valued relative to how they perform. We can see this when looking at the sectors that drive the performance of these markets.

The U.S. tends to behave like the global tech sector. So it isn’t surprising that the MSCI USA Index is valued like the MSCI World Information Technology Index, with a similar PE of 25. Strictly speaking, the U.S. stock market is composed of only about 20% tech stocks. So, in theory, the incredibly tight correlation of 0.99 between those two shouldn’t exist. But, in reality, it does. A bottom up weighting of the PEs of the stocks that make up the U.S. index misses the point of how the U.S. stock market actually behaves, and therefore, is valued.

The Eurozone is composed of 19 European countries and tends to perform like — and is valued just like — a combination of three different world sectors: financials, telecommunications, and materials. The MSCI Euro Index behaves like a mixture of .41x MSCI World Financials Index; .34x MSCI World Materials Index and .33x MSCI World Telecommunications Index. The weighted PE of those global sectors is 18, the same as the Euro index.

Let’s now look at Japan. The consumer discretionary sector is the largest sector of Japan’s stock market, which includes globally-recognized companies like Toyota and Sony. But the influence of financial conditions on all types of Japanese companies is evident in their performance which tracks the financial sector closely. Japan’s stock market is valued similarly to the MSCI World Financial Index at a PE of 15.

The takeaway from this comparison of countries and sectors is that the valuation differences between countries reflect how they perform and gives a very different investment conclusion from a simple comparison of the country PEs. Currently, these countries or regions do not appear materially over or undervalued relative to the sectors that they track. The sector PEs are all above average, but they are similarly valued relative to their 15-year histories. Each sector PE falls between 65% and 78% of that sector’s 15 year high.

All this suggests relative valuations do not currently favor one country or region’s stock market over another when seeking value. We favor asset allocations across borders in line with their strategic weightings in U.S. and international stock markets which mirror the weights in the broad indexes.

Diversification offers best value in 20 years

With stock markets valued fairly relative to how they perform there is little reason not to be globally diversified. From a diversification perspective, there hasn’t been a better time in 20 years to be globally diversified. The trend in correlation among countries has fallen to the lowest levels since the mid-1990s. Many investors have never seen this low correlation before in their investing lifetimes.

It’s not too late to buy. Valuations support a globally diversified portfolio offering the best diversification benefits in 20 years.
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About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC  

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.