Over the past decade, equity valuations have risen considerably, coming off the extreme lows in the immediate aftermath of the financial crisis, and today sit near long-term averages. A number of factors, including low interest rates and inflation, provide some explanation for elevated price/earnings (P/E) multiples. Investor/consumer optimism is another.
As illustrated in the chart above, there is a clear, positive (albeit imperfect) correlation between consumer confidence and equity valuations, demonstrating that P/E ratios can remain above average for extended periods of time when consumer confidence is high. That’s particularly clear in the late 1990s, when valuations were well above recent levels. Confident consumers are typically willing to spend, directly contributing to economic and earnings growth. That confidence also helps to lift valuation multiples.
Putting it all together, if consumer confidence remains high, equity valuations can also stay elevated (or even rise further) for a sustained period. If economic growth is stable or reaccelerates, the employment picture remains robust, and if several key macro events are resolved, consumers are likely to remain positive — an upbeat disposition that could continue to support higher equity valuations.
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