Mon, 13/01/2014 - 13:05
As the relentless bull market march in equities continues, alarm bells are ringing in many bear camps around the world, says Peter Garnry (pictured), head of equity strategy, Saxo Bank.
The talk is that equities are overvalued and many different indicators such as P/E Shiller and market capitalisation to GDP are presented as evidence. Our view is that equity valuations have finally reached normality and the multiple-expansion party is probably over for now. Thus rising stock prices are now solely dependent on revenue and earnings growth.
Let us look at the cold facts. Measured on six valuation metrics, global equities still remain a bit below the average observed since 1996. The z-score is minus 0.14 which basically indicates that valuation has now normalised. This means that global growth driving revenue and earnings will now have to deliver for indices to continue higher. Is that possible? The JPM Global Manufacturing PMI index has increased almost continuously since August 2012 and since April 2013 the index has accelerated, indicating that the global economy will pick up speed over the next six months. As a result, revenue should begin to accelerate as well.
For those readers that love their numbers fix, the table below shows the six valuation metrics and their actual values against the average observed since 1996. The conclusion is not clear-cut and one ratio, price-to-sales, is indicating that global equities are overvalued by 10.5 per cent. This divergence is likely due to the fact that the equity market has been going higher on earnings driven by profit margin expansion. So the historically high profit margin makes the index look slightly expensive on revenue but cheap on earnings and cash flow.
The spectacular S&P 500 bull run in 2013 has left many wondering whether US stocks have gone too far. Measured on the 12-month forward earnings multiple, the S&P 500 trades at 15.4 which is a bit below the average of 15.8 measured since 1999. However, the multiple expansion has been very explosive going from 11.8 in early June 2012 to 15.4 as of last Friday. The multiple expansion explains the impressive 32.4 per cent total return in 2013 despite more muted earnings and revenue growth.
The multiple expansion is done for now in the US despite economic fundamentals improving as the rising stock prices reflected expectations of an improving economy. As in global equities, US stocks will likely slow down this year and increase more on par with the underlying growth in earnings and revenue.
The equity risk premium line since 1995 is also still indicating that equities will outperform bonds but the gap is narrowing in fast. With improving economic activity in the US, the gap will be closed through a combination of rising stock prices in 2014 and rising interest rates pushing down bond prices.
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