Stocks are expensive.
“The typical stock in the S&P 500 trades at 18.1x forward earnings, ranking at the 99th percentile of historical valuation since 1976,” wrote Goldman Sachs’ David Kostin.
Kostin wrote that what clients ask about the most these days is how to trade in this expensive market.
His three recommendations in a note Friday are:
- CASH RETURN: Stocks that return cash to investors through buybacks and dividends will outperform. Between both, investors receive a 5% yield on average from S&P 500 stocks. Over the last 12 months, the S&P 500 has returned 14.4% in buyback and dividend yield, and Goldman’s total cash return basket of 50 stocks has returned 18.6%. Stock buybacks hit a record in February, and companies are expected to announce up to $US800 billion in repurchases this year.
- NASDAQ 100: In this expensive market, the Nasdaq 100 has stocks that offer investors growth as well as value. The 100 largest stocks on the Nasdaq are trading at a relative price-to-earnings ratio of 1.1x versus the S&P 500. Earnings-per-share growth for the Nasdaq 100 is forecast at 15% over the next year, compared to 5% for the S&P 500. “The current wide spread between forward EPS growth rates implies NDX will outperform S&P 500 during the next year,” Kostin wrote.
- TOPIX: Tokyo’s Stock Price Index, or TOPIX, also provides a good combination of growth and value, although investors must hedge for foreign currency movements. Goldman forecasts that 22% EPS growth in 2015 versus 8% for the S&P 500. The TOPIX is expected to rally to 1730 by year end, with a total return of 14% to investors. “But on a constant US dollar basis, the topix will return 6%.”
The bull market just entered its seventh year, and the S&P 500 has more than tripled during that period.