Some thoughts on the valuation of the European stock market, which Goldman Sachs points out is more than a standard deviation above the 14 year average. (Click to enlarge the chart.)
It’s difficult to argue relative to history that the market isn’t stretched; only in the tech bubble period were valuations higher for any sustained length of time
Stocks are basically bonds where the coupons tend to grow faster than the level of consumer prices. That makes equities sound like a great thing to own if you’re worried about inflation, and, in fact, Mr Stocks-for-the-Long-Run made this case a few years ago. While the actual article is more nuanced than the headline and opening paragraph would suggest — he admits that stocks only become immune to inflation over multi-decade periods — it’s still a bit misleading. The last time the rich world had to deal with meaningful inflation, it was bonds that beat stocks.
We’re reminded of all this because of two striking charts from a new report from Goldman Sachs on the implications of negative, long-term real interest rates. Consider the following chart, which compares the returns you would have gotten from buying and holding US stocks versus US 10-year bonds over decade-long periods: Read more
European stocks as measured by the Stoxx 600 index finally passed their March 2000 high this week. As measured by the FTSE Eurofirst 300 they are set to pass their 2007 closing high if they can hold on to today’s gains.
Great news for investors in Europe, right? Well, sort of.
First off, record highs for shares are only good news if you are selling: investors should care about the future, and the higher the price, the lower the future returns, so record high prices are not obviously good news for buyers.
Second, these are capital only measures, which exclude dividends and take no account of purchasing power. Third, share prices are not a great guide to economic performance for all sorts of reasons, but most obviously because multinationals garner much of their income from outside their listing location.
Another way to look at the effect of quantitative easing from Citi, the movement in risk premiums: down for fixed income, up for stocks.
That’s the title of a fascinating new paper from AQR’s Cliff Asness and colleagues, and we honestly couldn’t think of a better headline for this post. The authors present us with a fascinating puzzle: shares of smaller companies systematically do better than shares of big ones. There isn’t any obvious reason why this would be true, yet it is.
Long-suffering fans of academic finance theory might wonder why Asness et al wrote this paper, or why we are discussing it. After all, the idea of a “small-cap premium” has been around for decades and it’s one of the three factors in the Fama-French three factor model of stock pricing. Read more
In case you were wondering, strategist Jonathan Stubbs at Citi is still b-b-b-bullish on stocks.
Thanks go to Bazookas, Bull Markets, Bubbles, Barbells, Buybacks & Banks:
Markets in 2015: More bull — We stick with our end-2015 Stoxx target of 400. This implies c20% returns from current levels. Our bull case is founded on four pillars: 1) aggressive liquidity actions from the ECB to increase balance sheet size back towards early-2012 levels, 2) ECB QE, in turn, to support stabilizing, then improving, confidence, GDP and CPI across the Euro Area,
The newest issue of Men’s Journal contains an amazing story about people desperate to get rich by buying stock in companies exposed to the rapidly-growing legal US marijuana industry. (Hat tip to @modestproposal1 for alerting us to it.)
Written by Erik Hedegaard, the piece focuses on three characters: Read more
At the end of 2013, the CFA Institute surveyed its members on a range of topics, including the asset classes they thought would do best in 2014. The year isn’t over, but we thought it would be fun to update you on the status of those predictions.
Here’s a neat idea from the Morgan Stanley equity strategy team.
The consensus of fund managers is normally right, in that when most people want to own something it is probably worth owning. Normally being the operative word here, as when markets turn from boom to bust, or vice versa, that consensus becomes very wrong. Hence the common desire to make a reputation as the heroic contrarian who gets it right.
What Krupa Patel and co have done is to look at the performance of european equity funds over time to see if that might help identify the all important turning points. Unfortunately, it turns out not to be much use for market direction, but it may be useful in spotting more subtle changes in the popularity of investment styles, collectives shift from value to growth, for instance. Read more
Outflows from US high yield bond exchange traded funds slowed last week, according to JP Morgan, so that mini-correction in debt markets may have run its course.
Keep an eye on US stocks, however, as the mini-correction there has only seen 0.5 per cent of the assets in equity ETFs withdrawn since June 24th, leaving further outflows as a potential source of vulnerability, in the judgement of strategist Nikolaos Panigirtzoglou. Read more
Ken Fisher, Forbes columnist and money manager billionaire, took to the pages of the FT in June to poke advocates for small listed companies in the eye.
You don’t want to hold speculative stocks late in a bull market. Don’t be seduced by the siren song of small beats all.
The idea that a collection of small capitalisation stocks are always a better investment than a collection of stodgy and safe big companies is a myth, he wrote.
Macquarie, however, went away and had a look at the data, and they disagree. Although the better conclusion might be about the nature of these types of arguments more broadly. Read more
That uneasy feeling when everything is going well. Is it deserved? Can it last? Should you cash in and go paint watercolours in that studio on the Pembrokeshire coast?
Strategists are not immune, with a summer bout of the temporaries upon us. Goldman is the latest, downgrading its view of stocks over the weekend but without really committing to it:
We also downgrade equities to neutral over 3 months. We are concerned that a sell-off in government bonds will lead to a temporary sell-off in equities in line with what we saw last summer, though the magnitude is likely to be smaller as the need for bond yields to correct is lower than it was back then.
A counterpoint to worries about the stuffy air of silence settling on markets arrives from Citi. Fear not the market calm, it is an unreliable sign of things to come.
There is little relationship between market volatility and future equity returns over any time horizon. Current low levels should not be seen as a clear sign of investor complacency and an imminent market correction.
Pickers of stocks cannot relax, however, because while market level volatility is low, it turns out that “style volatility” is up. Read more
We’ll see your bullish forecast, and we’ll raise you, Brian.
That’s Brian Belski, the BMO strategist who thinks that 10 per cent annual returns for the next decade are plausible for the US stock market. Read more
A quiet reformation continues.
One of the central articles of investing religion — that a forward price earnings ratio is a useful indicator of stock market value — is under sustained intellectual assault. Read more
From JP Morgan Asset Management. Tantalisation comes from the end of the black line, which you will note has perked.
This is an abridged version of a post by Andrew Smithers for his FT blog, one that lays out why using next year’s PE ratio to value the stock market is absurd. Taking the Fed Chair to task for her language, it is also ripost to the critique of long term valuation measures we have also featured.
Janet Yellen, the Fed’s head, rather bizarrely used the prospective price/earnings ratio, one of the weakest of all measures, to justify a statement that Wall Street was not overvalued. (This was doubly strange since her husband, George Akerlof, co-wrote a book with Robert Shiller, who has championed a much better measure…
I quote from a recent Buttonwood column in The Economist. Calling Ms Yellen’s comment “strange” seems very kind. Many people would rate the use of bad data in preference to better as irresponsible rather than strange, particularly when it carries with it the authority of the US Federal Reserve. Read more
One day, maybe, companies in Europe will stun those paid to forecast these sort of things with an explosion of profitability. The gusher of earnings will arrive to justify the steady rise in the valuations of companies expected to produce them.
For now though, the story is the same as it has been since 2010: negative revisions. According to the strategy team at Goldman Sachs, what had been hoped for this year was 13 per cent growth in profits, but six months in that has dropped to 7 per cent with the cuts broad based. Actual growth in reported earnings was 1.5 per cent in the first quarter, compared to that which preceded it.
There is hope, or at least explanation, however. It was ever thus: Read more
We detect a theme. It may be that with financial markets becalmed a new subject is needed. Perhaps it reflects the way Piketty has become an instant bookshop-to-shelf classic, but something has investment strategists reaching for insight from an eighth century theologian.
“And those people should not be listened to who keep saying the voice of the people is the voice of God, since the riotousness of the crowd is very close to madness.” — Alcuin to Charlemagne, 798 A.D. Read more
To take a tiny bite of a very large subject, what is the ideal asset allocation for a long-term minded investor?
Providing an answer has made a lot of people a lot of money over the years, typically when couched as a response to another unanswerable: how much risk to you want to take? (Er, a bit, but not too much. What do most people do?)
The typical answer that is sold, however, has changed over time as well. Read more
Welcome to boom time in the UK. There, we said it. Or rather we’ve spotted that the optimistic Jonathan Stubbs at Citi has said it. There is a buzz, and it is all about the Bs.
Bull Market — Boom, Bids, Base Rates, Builders & Big-Caps
Global recovery, UK boom — Our economists expect progressive recovery of global economy in 2014-15 with GDP growth of 3.1% this year rising to 3.5% in 2015, from 2.5%in 2013. Recovery led by US and Europe/UK. EM headwinds not strong enough to derail growth. UK survey data very strong, eg new orders, hiring and investing intention. Boom time.
Further evidence arrives that if you are looking for value stocks in these markets, then you are going to have a tough time of it.
Millennial Invest has charted the change in the dispersion of valuations over the last five years for the US market. What he finds is that it is not just the average valuation that rose in the long post crisis bull market, but the range of valuations has narrowed as well as the market has become much more homogenous.
What he looks at is something called the Ebitda yield. Read more
If we know one thing about investing, it’s that time and the power of compounding make stocks an essential holding for savers, right?
Well, maybe not, at least when the choice is to hold bonds with a reasonable yield instead and the excess returns from stocks have been on a long term downward trend, something suggested by this presentation from Claude Erb, the West Coast based manager of TR.
Which is going to take us on a mostly chart based and, we hope, relatively painless tour of a wonky concept — the equity risk premium. But it’s also a way to come at those arguments about long term measures of stock market valuation, the Cape ratio and Shiller PE, from another direction. Read more
Tech is down, Treasuries are up, stocks are flattish: whatever happened to asset rotation, great or otherwise?
For an answer, we turn to the flows as interpreted by Nikolaos Panigirtzoglou and team at JP Morgan, who have found that the bond selling of late last year has reversed:
non-bank investors appear to be responsible for most of this year’s bond rally of which retail investors were one. Neither speculative investors, who appeared to have increased their US rate shorts by $110bn duration-weighted YTD, nor banks who, driven by FX managers, sold USTs this year, appear to have caused this year’s bond rally.
About that European bull market. Enthusiasm is there, but the earnings not so much yet.
With little support from earnings, European equities continue to be re-rated in P/E and price/book terms. From 10x in late 2011 to 17x now, European equities trade above both post-1980 and post-1990 average P/Es.
Citi strategist Jonathan Stubbs finds that it’s not just the average, value stocks no longer offer great value either. So, look for places where corporate earnings are actually, y’know, growing. Read more
So, havens were what worked in the first quarter, led by a niche precious metal.
Double double, toil and trouble…
Morgan Stanley’s US quant team has an eye on the market cauldron, and the simmering has a late nineties feel to it: Read more
Big declines for the Japanese benchmarks, with the Nikkei 225 rapidly approaching 14,000 from the wrong direction to leave it and the broader Topix firmly in correction territory.
There are reasons aplenty. Japan vied with Portugal for most go-go market last year, Chinese growth appears to be slowing, the US had a bad day, and then there is the whole taper-related, Turkey-inspired return of general angst.
Still, momentum watchers may have reason to be concerned by the following chart: Read more
So yes, the Cape measure of long term valuation might have some flaws, but don’t expect them to keep a good bear down. The latest from Andrew Smithers provides some more (over) valuation points to chew on. Read more
Pop quiz – what was the price earnings ratio for the UK benchmark at its previous peak of 6,722 in October 2007?
We ask because the FTSE 100, now slightly higher, is near as dammit at the same valuation once again. But the real surprise is perhaps the lowly level of that ratio. Read more