The U.S. stock market is becoming fully valued, with the market trading at 14.5 times forward earnings.
True, corporate earnings are still good and could get even better in the months ahead, especially if global economic conditions improve and the dollar’s appreciation takes a pause. But over the longer run, corporate profit growth will inevitably gravitate toward nominal GDP growth, which should be around 4-5%per annum.
Expected returns in U.S. common stocks should be around 6% (with a dividend yield of 2%). Anything above this expected return should be considered excessive, and would rely on continued multiples expansion. Such expansion remains possible, but will depend on the interaction between the U.S. economy and Federal Reserve policy. Any increase in interest rate expectations may not be conducive for a continued upward re-rating of equity multiples.
The bottom line
The risk-reward trade-off in U.S. stocks is less appealing now that equity prices are in the fair-value range. We are comfortable with our neutral stance for now.
Article courtesy of http://bcaresearch.com