Want some reassuring commentary that all is well and good in the world of equity valuations?
Well, here’s a pretty bullish bubble-bashing view from UBS, suggesting arguments for a big imminent correction are unwarranted. As economists Larry Hatheway and strategist Kenneth Liew write on Friday (our emphasis):
In our view, a large correction remains fundamentally unwarranted. We find little evidence to support the assertion that the 2009 market rally represents a liquidityinduced ‘bubble’, or that the recent spate of market choppiness is a function of over-valuation. Equity P/E multiples are near long-term averages on cyclically depressed earnings, and do not discount optimistic long-term growth.
Rather, we believe recent price action signals a transition from the strong rallies of 2009 to a bumpier, more uneven period ahead. Greater asset price fluctuations are to be expected, reflecting the uneven and abnormal nature of this recovery cycle. Indeed, we believe equity markets can continue to rise as economic conditions improve, albeit at a slower pace and with higher volatility.
We therefore retain our current asset allocation stance: Overweight global equities, with smaller overweight positions in high-yield credit and cyclical commodities. We are market-weight in REITs, government bonds and inflation-linked bonds. We also have a heavy underweight allocation in cash.
As for all that bubble-talk:
Recently, some observers have argued that the strong recovery of equity, commodity, credit, and Asian property markets represents a ‘bubble’, driven by easy monetary policies and ‘carry trades’ in the US dollar. According to this view, asset prices have little fundamental foundation, and are apt to move sharply lower as central banks around the world raise interest rates next year and as the effects of fiscal stimulus fade.
We disagree. In our opinion, it is simplistic to conclude that just because rising asset prices rallied in an environment of easy monetary policies, the result must be liquidity-induced ‘bubbles’. That thinking ignores the fact that the starting point of the rally in March 2009 came when investors feared the worst— systemic banking failure, depression, and deflation. As the evidence began to point to something less bad, markets recovered sharply. And for all their gains since March—global equities are up over 50% from their lows—prices are still more than 30% below the peak reached in 2007.
Also, even after their strong run, most asset prices are not stretched relative to fundamentals. For example, our US strategy team expects Q4 S&P 500 earnings to be $17 (up from $16.15 in Q3), or an annualized $68. At a ‘fair’ P/E of 15x, the S&P 500 index ought to trade at around 1020. Recent prices were about 5% above that level—that hardly qualifies as a ‘bubble’. Moreover, global P/E multiples, on either trailing or forward earnings, trade near long-term averages. And that is despite the fact that the earnings on which the multiples are based remain relatively depressed (Chart 1 and Chart 2). In other words, equity prices have not discounted robust cyclical or structural growth rates
Although, as Hathaway points out, that’s not to say that some emerging market assets — particularly in Asia — don’t have the potential to develop into speculative bubbles, because of the gap between low funding costs and high growth. But we’re not there yet, he says.
You can find the full report in the usual place.
Related links:
Dollar rise *alert* - FT Alphaville
Asset bubble warnings, international monetary institution edition - FT Alphaville
China is `the most obvious area of concern’, Fitch says - FT Alphaville
