Despite the extended bull market, we do not believe U.S. equities are overvalued. There is a subset of growth stocks that have advanced to extremely high valuations, primarily in the biotechnology and technology sectors. Outside of these areas, however, valuations do not appear to be stretched.
Look for earnings growth
In this environment, we are focused more on growth rates, with slightly less emphasis on valuation. It is worth noting, as we did at the close of 2013, the unusual level of valuation parity across the U.S. equity markets. That is, most stocks are trading at a similar price-earnings ratio. Investors are essentially paying the same price for companies with varying degrees of growth potential.
Dividend growth remains likely
Among dividend-paying stocks, we remain particularly optimistic about dividend growth potential. Along with a continued increase in the number of U.S. companies paying dividends, payout ratios - a measure of how much of a company's earnings are paid in dividends to shareholders - remain at historic lows. The S&P 500 payout ratio is low from a historical perspective and also when compared with payout ratios in non-U.S. markets.
Many opportunities for active research
Our outlook for U.S. equities is slightly less constructive than it was a year ago. However, we believe stocks in many sectors still have room to advance, even if returns are likely to be more modest overall. We continue to find opportunities across the U.S. equity universe, due in large part to our fundamental research and the support of equity analysts who provide differentiated, independent ideas.
The economy fuels optimism
A research-based approach to portfolio construction is particularly important in today's market, where equity correlations have declined, stocks are performing more independently, and investors appear to be more focused on fundamentals. Despite some disappointments in economic data in the early months of 2014, we remain optimistic about an improving U.S. economy, with housing and employment trends suggesting a solid backdrop for growth in 2014.
Read more about themes in equity markets in Putnam's 2Q Equity Outlook.