Stocktake: Markets’ valuation gap points to where long -term returns will be

Investors’ cautious response to excellent US earnings reflects the fact that valuations really are in elevated territory right now.

The S&P 500 now trades on a cyclically-adjusted price-earnings (Cape) ratio of 36.6 – the highest in the world and higher than 98 per cent of historical readings, notes MarketWatch's Mark Hulbert.

It's not necessarily cause for concern, argues Ritholtz Wealth Management's Ben Carlson, who says valuations deserve to be in bubble territory. Zero interest rates, massive government spending, a roaring economy and an accommodative Federal Reserve – it "makes sense" that stocks are so high.

Perhaps, but the fact other developed markets trade at such a discount to the US is worth noting. Data from Barclays shows that over the last four decades, the US has generally traded on a higher Cape ratio than Europe, but the gulf has never been as wide as it is now (Europe trades on a Cape of 23).

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Valuations are useless for market timing, but they are a decent guide to long-term returns. In other words, they may not matter too much today, but eventually, they will.