As equities continue their excellent run, some commentators are tying themselves in knots to demonstrate they remain good value. One argument we have seen, for example, runs that even though European equities have more than doubled in price since their 2009 lows, they are actually now the cheapest they have been in decades.
How, you may be wondering, is that possible? If they are that cheap now, surely they would have been even cheaper in 2009? Well, yes, in absolute terms, they would have been. But this argument is looking at matters in relative terms and can point to a range of statistics and graphs to prove that – relative to cash, government bonds and corporate bonds – the last time equities were this cheap was just after the Second World War.
That is all true but so is the fact this state of affairs has not been caused by a collapse in equity prices but by historically low interest rates brought about by quantitative easing measures that have seen cash deposit rates and bond yields collapse. With yields on European BBB-rated bonds dropping from 7% to 3% in the space of 18 months, for example, it is little wonder equities are cheaper by comparison.
The people making the case for continuing to buy equities have come up with some follow-up arguments, with which we do have some sympathy – for example, companies will be able to take advantage of lower interest rates to negotiate more affordable loans and boost profits growth or else use the cheaper debt available to fund share buybacks or merger and acquisition activity.
All of that notwithstanding, however, we would struggle to see this as a conclusive case for equities – precisely because it is a relative case. Equities are not cheap in themselves – they are cheaper than other more expensive assets. To put it another way, just because you have the nicest house on a horrible street, it does not necessarily mean you have a nice house.
So while the technical element of this relative case for equities is impressive and the logic – on its own terms at least – infallible, that does not mean we should abdicate responsibility for the investments we make based on the absurd valuations of other asset classes.
As we argued in Grains of truth – and no matter what you may read and hear elsewhere – some equities are attractively valued in themselves, others are not. This is a time for investors to be treading carefully.