The economy seems to be on the mend.
Housing is bouncing back. Household debt levels are low. With dividends, stocks are at an all-time high. Europe is addressing its problems. Energy prices are falling. America is enjoying an oil boom for the first time in decades. There's a lot to be thankful for as we enter 2013.
But for investors, there's one big caveat: valuations.
Depending on how it's measured, valuations of the Dow Jones (DJINDICES:^DJI) or S&P 500 (SNPINDEX:^GSPC) are a bit rich. Some tech giants like Microsoft (NASDAQ:MSFT) trade at low earnings multiples, but others, particularly high dividend paying stocks like utilities, are richly valued. That could mean strong economic growth won't necessarily translate into strong investor returns, as the good news is already priced in.
Two weeks ago, I sat down with Mohamed El-Erian, CEO of PIMCO, one of the largest money managers in the world. He echoed a similar view: There's a lot going right in the world, but valuations could tamper investor returns. Here's what he had to say (transcript follows).
Morgan Housel: Do you feel better about 2013 than you did 2012?
Mohamed El-Erian: That's a really hard question. So if I didn't look at valuations, I would tell you yes. The U.S. economy has healed relative to the end of 2011. Our housing market is in a really better place than it was before, so there's been -- the corporate sector has continued to heal, and there has been some healing on the housing side. So I would say the U.S. is in a better place. Europe has gone from denying it has a problem to denying it, but not understanding that it needs to get ahead of it, to now trying to get ahead of it.
So, I would put Europe is in a better place and I would say that China now has clarity over its political transition. So if I were to look just at the three big economies, I would feel better. When I look at market valuations, I get a little bit nervous, because market valuations have not only incorporated all of this, as rightly they should, but they've assumed that all this will continue and will continue well into the future. And I'm much more nervous about that. I worry a little bit that market valuations are ahead of what can be achieved, and that there may be disappointments going forward.
Fool contributor Morgan Housel has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft. Motley Fool newsletter services recommend Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.