The stock market could still be noticeably undervalued even in the face of fresh records this year, believe it or not.
And investors could thank global policy uncertainty — primarily trade battles with China and the European Union — for being locked out of those meatier gains in equities. UBS strategist Keith Parker estimates that the S&P 500 is at least 8% undervalued due to global policy uncertainty alone.
Parker’s research shows that based on the The Baker, Bloom and Davis Index — which measures policy uncertainty trends — global policy uncertainty rose back to peak levels of the last five years just following June’s G20 meeting. That “spike” in policy uncertainty, as Parker refers to it, has triggered a compression in the price-to-earnings multiple of the S&P 500. By Parker’s estimation, the PE multiple on the S&P 500 is close to two times too cheap right now.
But in order to unlock that untapped PE multiple expansion, and the likely pop in stocks that would come with it, policy uncertainty would have to decline. That’s a tall ask with the unpredictable Trump administration, a borderline confused Federal Reserve and ongoing Brexit chaos.
Parker is optimistic, nonetheless.
“While we see policy uncertainty unlikely to revert to the 2005-07 lows, we do see a growing case for uncertainty to decline absent further shocks or recession – given the G20 détente, central bank pivots and China stimulus,” Parker says.
Invesco chief markets strategist Kristina Hooper agrees with Parker. Hooper told Yahoo Finance policy uncertainty is “significantly” holding back the markets.
“We have seen this historically, when you have high economic policy uncertainty it leads to lower business investment and lower hiring,” Hooper said on Yahoo Finance’s “The First Trade.”
Parker said a potential firming of policy plans moving forward means risk to the defensive sectors of the stock market that investors have piled into this year. Those names range from consumer-packaged goods companies such as Hershey to a media giant like Disney.
Explains Parker: “The relative forward P/E of high vs low-beta stocks globally has fallen toward a record >35% discount, levels seen in early 2009. Thus, a decline in uncertainty could fuel a rotation out of low volume/defensives to select value/cyclical stocks.”