Charles Schwab Lays Out Why Stocks May Not Be Overvalued

Stocks have been going up every month in 2017, but that doesn't mean they are in overvalued territory, which could present an opportunity for investors. That's according to Jeffrey Kleintop, senior vice president and chief global investment strategist at Charles Schwab, who said this week that, while stock valuations are above average, the same can't be said of the price-to-earnings ratio, which may come as a surprise to investors.

"Since the inception of the MSCI World Index – that was back in 1969 – when we have P/Es in the range of where they are now – right now about 21.3 on that MSCI World Index – anytime they've been plus or minus half-a-point of that, returns have averaged over the next 12 months, anywhere from negative 5% to positive 45%," said Kleintop. "It's a pretty wide range, and the average has been plus 17-1/2%, so there's no reason based purely on valuation why stocks couldn't go higher over the course of the next year, despite above-average valuations." The MSCI World is a market capitalization-weighted stock market index covering 1,652 stocks around the world.

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Higher-than-average valuations for stocks around the world can be attributed to global growth this year. But still, Kleintop said there are some markets that are pricier than others. He pointed to the U.S. as one example. U.S. stocks have a price-to-earnings ratio of around 25. In comparison, Kleintop said that the MSCI Euro Index, which tracks the stocks in 19 Eurozone countries, has a P/E of 18. According to the executive from The Charles Schwab Corporation (SCHW), the MSCI Japan Index is at a price-to-earnings ratio of 15, which is also cheaper than the U.S.

Still, Kleintop believes that all three indexes are fairly valued when looked at in terms of what the indexes are tracking. The U.S. MSCI Index closely tracks tech stocks and has a similar valuation to the MSCI World Information Technology Index, while the MSCI Euro Index tends to move in line with the financials, materials and telecom sectors, and the MSCI Japan Index closely tracks the financial sector. Both MSCI Japan and the World Financial Index have a price-to-earnings ratio of 15.

"All of it all it suggests relative valuations don't currently favor one country or region over another, and it makes sense to be globally diversified right now across borders in line with strategic weightings," said Kleintop. "That means that your international weighting should broadly correspond to what you see in those major global indexes."