Bloomberg News After another big year for stocks in 2013, many investors are questioning how much longer the bull market can run before it collapses from exhaustion. This doubt has intensified with the early 2014 selloff. However, based on what we see, it's not time to worry about the market's stamina yet.
The S&P 500 returned more than 32% in 2013 — the fifth-straight year of positive equity-market returns and the best year since 1997. As the market chalked up these strong gains, earnings per share grew by about 6%. So there was a significant increase in the price/earnings ratio — the amount investors pay for a dollar of S&P 500 earnings.
How much room is there for P/E multiples to expand, paving the way for further gains? Some investors aren't convinced that they'll expand at all — they seem more worried that multiples could head in the other direction if interest rates rise. Proponents of this view point to the modest market correction when (now former) Federal Reserve Chairman Ben Bernanke mentioned tapering at the May Fed meeting. The pain was acute in interest-rate-sensitive sectors, including those linked to housing.
But we think they're discounting the powerful new market highs in the last few months of 2013 against a backdrop of rising rates, stronger economic data and the actual onset of Fed tapering. Despite talk about a “bubbly” market, the P/E multiple for the S&P 500 was about 16 times at year-end. While that's higher than it was two or three years ago, it still reveals stock valuations to be modest — and dramatically lower than the two prior market peaks in 2000 and 2007. Earnings yields are also more attractive versus bond yields than in those earlier periods.
In our view, if interest rates rise gradually and economic growth accelerates (as we expect), the powerful bull market isn't likely to lose steam yet. What's driving our positive outlook?
Relative valuations: Even after five
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