What impact has recent market performance had on equity valuations?

Over the past year, global price/earnings (P/E) multiples have come down considerably from above-average levels for several major indexes to more attractive levels.

Certainly, negative performance has played a role, but continued earnings growth has also contributed to the decline. Large-cap U.S. stocks P/Es remain a bit high compared to the long-term average, although a good degree of froth has come out of the blue-chip market over the past year. More notably, small-cap equities and foreign stocks have also experienced a sharp decline to below-average levels. Small caps are particularly attractive, with valuations now meaningfully below their historical average.

In recent months, questions about the economic, inflation, and interest rate outlook have grown. Uncertainty around those factors have been the driving catalyst behind market volatility this year. A growth slowdown or an outright recession can’t be ruled out, although economic data at this point remains mixed. A more pronounced slowdown would weigh on corporate earnings, a potential outcome that is increasingly being priced in by investors at the same time that higher interest rates are also being absorbed.

As sources of uncertainty clear and the economy reaccelerates, corporate earnings growth will in due time also regain momentum, providing a solid underpinning to equity returns.

Setting aside those cyclical factors, long-term equity returns tend to be stronger when starting with a tailwind of lower attractive valuations than from a starting point of elevated P/E multiples. Today, valuations look better than they have in some time. Whatever the near term may hold, we expect that long-term investors will be rewarded for taking risk and staying invested.