Conventional metrics like the Price to Earnings, Enterprise Value to Sales, Price to Free Cash Flow all suggest that global equities are expensive when compared to their own history. This assessment does not sound reasonable to some observers as the macroeconomic environment could be rightly described as “early-stage recovery” and there is a high degree of uncertainty in the long run.
The Outlook Report 2021 by JP Morgan bank seems to disagree with the above statement and suggest several reasons as to why such valuations can be justified. First, the biggest companies in the world have pristine balance sheets and stable growth profiles underpinned by secular growth trends. With the Federal Reserve working to backstop lending and support markets, we find that the largest weights in the equity market have a low risk of default, hence supporting higher equity valuations.
Another important factor is that globally, interest rates are low. Low-interest rates support equity valuations in two ways: first, future earnings streams are discounted at a lower rate, and second, equities appear to be more attractive to investors as dividend earnings and cash flow yields are higher than fixed-income yields.
We find the takeaway for investors is such that high valuations at the index level are underpinned by strong fundamentals and impressive cash flow, earnings, and dividend streams.