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Valuation vs. Momentum: Which has mattered in 2014?

Valuation is a key determinant of an assets future return and risk overpay and returns will likely be lower, but finding value can lead to superior returns and a margin of safety that lessens risk of loss.12.15.14

Market performance in recent years has been dominated by assets classes with higher valuations and price momentum, such as the S&P 500, REITS, long-term treasuries, and utilities.

The chart (top right) illustrates the price/sales ratio of the S&P 500 relative to the MSCI EAFE (foreign developed market stocks) and MSCI Emerging Markets Index. The price/sales ratio of these two foreign indices is roughly 43% below that of the S&P 500, suggesting superior longer-term return potential. In 2014, however, foreign developed stocks and emerging market equities have returned -4.7% and -4% respectively, versus 10.5% gain for the U.S. market.

REITS are another example of an overvalued asset class topping the performance leaderboards. The S&P REIT Index has risen 23.8% this year, despite a price/sales ratio equivalent to levels seen during the real estate bubble in the mid 2000s.

While valuation is a key driver of future returns, it is not necessarily the best timing indicator. As a result, investors allocated to undervalued sectors, such as foreign developed and emerging markets, must maintain a level of patience until valuations relationships normalize.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.

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