Cheap is converging with expensive in the American equity market, narrowing options for investors looking for bargains after the broadest rally on record lifted almost 90% of the Standard & Poor’s 500 Index this year.
The difference in valuations shrank to the smallest since at least 1990 after companies such as Hormel Foods Corp. and CenterPoint Energy Inc. rose to levels that match Ralph Lauren Corp. and Citrix Systems Inc., whose five-year average profit growth rate is twice Hormel’s and CenterPoint’s. A measure of the dispersion of price-earnings ratios in the S&P 500 compiled by Goldman Sachs Group Inc. narrowed to 41% in June, the lowest on record, and held around that level since.
While four years of earnings growth and the Federal Reserve’s near-zero interest rate have led the S&P 500 on a 166% rally since March 2009, they have also driven up valuations just as the bull market approaches the end of its fifth year. The monolithic market means investors may have nowhere to hide should shares fall.
“We’ve seen a runup in prices in the market, and we don’t think it’s cheap anymore,” Bruce McCain, who helps oversee more than $20 billion as chief investment strategist at the private- banking unit of KeyCorp in Cleveland, said in a Nov. 13 phone interview. “Those who simply like to buy cheap and get a regression to the mean may have less luck.”
The S&P 500 climbed 1.6% to a record 1,798.18 last week after Fed Chairman-nominee Janet Yellen signaled she will continue the stimulus programs of her predecessor Ben S. Bernanke, and retailers suggested holiday demand would be stronger. The measure advanced 26% in 2013, on track for the biggest annual return in a decade. The S&P 500 rose less than 0.1% to 1,798.92 at 9:48 a.m. in New York, after topping 1,800 for the first time in early trading.
More than 440 of the S&P 500’s companies have gained in 2013, the most for any year at this point since at least 1990, data compiled by Bloomberg show. Advances since March 2009 have been spread among all 10 S&P 500 groups, with consumer discretionary shares up 309%, about four times the jump in shares of utilities companies. In the bull market from 2002 to 2007, energy stocks outpaced consumer staples shares by about sixfold.
The breadth of this year’s rally has led valuations throughout the market higher. The average S&P 500 company’s price-earnings ratio rose 40% to 20 in 2013, twice the increase for 2012 at this point of the year, according to data compiled by Bloomberg.
“This market clearly has had a life of its own that’s been divorced from a lot of economic reality, and so valuations are much higher,” Martin Leclerc, founder of Barrack Yard Advisors LLC, said in a Nov. 14 phone interview from Bryn Mawr, Pennsylvania. His firm oversees $230 million. “Everyone bemoans the fact that the set of companies selling at very good prices has really been diminished.”
Health-care shares saw the biggest multiple expansion this year, trading at 17.5 times estimated earnings last week, the highest since 2007. A group of consumer-staples stocks trades at 18.6 times estimated earnings, compared with the average of 16.4 before the bull market, according to data since 1990 compiled by Bloomberg. The price-earnings ratio for utilities shares reached 16.1, compared with the 13.8 average before 2009.
“The mantra was bond-like stocks for 18 months, from the middle of 2011 until Bernanke said the word taper,” Eric Green, director of research and fund manager at Penn Capital Management, said by phone Nov. 14. The Philadelphia-based firm oversees about $7 billion. “The uncertainty has forced individual investors and institutions into more defensive types of stocks.”