High equity valuations not an impediment to further gains, says UBS

Investing.com -- After a robust 2024, UBS said in a note Tuesday that concerns about high valuations are surfacing. 

The S&P 500 's forward price-to-earnings (P/E) ratio now stands at 21.5x, surpassing the 10- and 20-year averages of 18x and 16x, respectively. However, UBS analysts suggest that these elevated valuations might not be a cause for alarm.

According to UBS, "high valuations reflect the positive macro backdrop." 

They point to factors such as low inflation expectations, declining unemployment, and stable economic growth that contribute to higher-than-average valuations. 

The investment bank believes these supportive conditions will persist through 2025, underpinned by stable economic growth, falling inflation, and continued AI-related investments.

Historical data indicates that high valuations are not always tightly linked to market returns. UBS notes, "Valuations tend to have very little correlation with returns over the 12 months that follow." 

While stocks may fall when corporate profit growth disappoints, the bank says they do not typically decline simply due to high valuations. 

Instead, UBS suggests focusing on changes in earnings expectations as a more reliable indicator of market direction.

“We think that forward earnings expectations will continue to rise, which tends to correspond with periods where stocks rise higher,” wrote the bank.

They project a 9% profit growth in 2025, supporting their forecast for the S&P 500 to reach 6,600 by year-end.

“In our base case, we expect the bull market to continue with the S&P 500 reaching 6,600 by the end of the year, primarily driven by healthy profit growth of 9%,” adds the bank. “With several known market risks ahead, we see scope for under-allocated investors to use potential near-term turbulence to add US stock exposure, including through structured strategies.”

Source: Investing.com