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BIS weighs in on debate about stock valuations

Reuters

Traders work on the floor of the New York Stock Exchange in New York on Friday.

Bloomberg MADRID (Bloomberg) — The Bank for International Settlements added its voice to institutions questioning whether stocks have become too expensive, saying they look “frothy” — particularly in the U.S.

The BIS weighed in on the debate just days after Goldman Sachs Group Inc. said a prolonged bull market across stocks, bonds and credit left its measure of average valuation at the highest since 1900. Stock prices are above historical averages and U.S. companies may struggle to continue their pace of dividend growth, the BIS said in its quarterly review on Sunday.

Warnings on elevated asset prices have become more frequent as the world’s biggest central banks move toward tighter monetary policy. A Bank of America Merrill Lynch survey showed a record 48 percent of investors say equities are overvalued. Nobel-Prize winning economist Richard H. Thaler said in October he can’t understand why stocks are still rising. The California State Teachers’ Retirement System CIO said last week that holding shares feels like “sitting on a pin cushion.”

The paradox is that financial conditions have continued to ease even in the U.S., by far the most advanced in increasing interest rates, leaving investors struggling to judge how rates will drive prices. “Ultimately, the fate of nearly all asset classes appeared to hinge on the evolution of government bond yields,” the Basel, Switzerland-based institution said. “There is also significant uncertainty about the levels those yields will reach once monetary policies are normalized in the core jurisdictions.”

Historical comparison

The price-earnings ratio of the U.S. stock market, cyclically adjusted, was recently above 30, exceeding its post-1982 average by almost 25 percent, the BIS said.

While that’s below the peak of 45 reached in the dotcom bubble of the late 1990s, it’s nearly double the long-term average of 1881 to 2017. The gauges for European and U.K. equities were at their post-1982 averages.

The BIS’ focus on interest rates as a driver of prices is no surprise, given that it acts as the central bank for many of the world’s monetary institutions that set benchmark rates. It didn’t give a definitive assessment in the over-valuation debate for stocks. Rather it said bond-market yields show even more froth than stocks, based on historical standards.

The BIS has long pushed for tighter monetary policy. It said central banks are a key factor factor behind looser conditions even as the Federal Reserve and Bank of England raise rates and the European Central Bank signals the end of its bond-buying program is nigh. It suggested that they’re mollycoddling markets by moving exceptionally gradually and signaling changes far in advance.

While central bankers are wary of undermining the post-financial crisis economic expansion, the retiring head of the BIS warned last week against moving too slowly.

“Postponing normalization too much also has risks,” Jaime Caruana said in an interview. “Why? Because there is more risk-taking and it’s difficult to know where the risk-taking will go.”

Stock valuations may drop when the dividend and buyback frenzy eases. In the U.S., companies increased their share of net income paid out in dividends by more than half over the last five years as buybacks swelled. The dividend payout ratio is back to the relatively high levels of the 1970s and therefore may be reaching an “upper bound,” the BIS said.

“When and if interest rates begin to rise, corporates may have the incentive to tilt their capital structure back to equity, or at least to reduce stock repurchases, which could raise further questions about stock market valuations,” the report said.Speech

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