Snapshot

Which stock markets look ‘cheap’ after the rapid rebound?


Despite everything that 2020 has thrown at it, at one stage the US stock market was up for the year overall. Other markets had also regained a lot of lost ground. This has occurred while corporate earnings are falling, forecasts are being slashed, and dividends are being cut.

Things look a little better after markets fell heavily recently. However, with the “cheapness” that was in abundance earlier in the year all but evaporated, to be positive on equities from here you really need to rely on the view that the post-lockdown recovery is sustainable.

How do current valuations compare with history?

The table below shows a number of valuation indicators compared with their average (median) of the past 15 years, across five different regional equity markets. Figures are shown on a rounded basis, with the shading indicating the degree of expensiveness or cheapness compared with the 15-year average.

20200702_hk_eng_chart_1.jpg

A disconnect with the economy and corporate fundamentals?

It is true that the economy and the stock market are not the same thing, as we have written before. Just because the economy is going into a nosedive does not mean that the stock market will do likewise. For one thing, share prices are forward looking, taking account of what is expected for years to come, not just the here and now.

Nonetheless, the incongruity we are seeing, with share prices rising while every measure of corporate health you care to look at is worsening, is really something.

This can be seen in the chart below, which shows how various indicators of corporate health which matter to stock market investors have changed since markets bottomed on 23 March.

20200702_hk_eng_chart_2.jpg

Even if we look further out, to the end of 2022, US, European and UK earnings are forecast to be around 10-15% lower than was the case on 23 March. It is hard to view this as anything other than a very “frothy” market environment.

Stocks may be expensive but so is everything else

So, what could this mean for investors? Cash rates are next to nothing and the long-term return prospects from bonds at current yields remain well below what investors would have got in the past. This leaves investors in a bit of a quandary. Stocks may look expensive, but so does everything else.

In fact, when you compare the relative value of global stock markets with other asset classes like bonds, they offer pretty decent value. In practical terms, expected returns for all asset classes are below historical norms but the additional premium available from stocks over cash or bonds remains attractive (although it is important to note stocks are generally seen as a ‘higher risk’ investment).

Diversification can help navigate uncertainty

In relative valuation terms, the US stands out as being the most expensive stock market. However, this is a title that it has held for the past decade without it being a barrier to its outperformance.

Non-US markets appear cheaper but come with additional risks – Europe is plagued by low growth and tensions within the Eurozone; the UK market is exposed to movements in commodity prices; Japan is a serial underperformer; and emerging markets are vulnerable to a combination of slowing commodity demand and weaker growth in China.

Diversification is one of the tools longer-term investors can use to navigate this uncertainty.

A few general rules

Investors should beware the temptation to simply compare a valuation metric for one region with that of another. Differences in accounting standards and the makeup of different stock markets mean that some always trade on more expensive valuations than others.

For example, technology stocks are more expensive than some other sectors because of their relatively high growth prospects. A market with sizeable exposure to the technology sector, such as the US, will therefore trade on a more expensive valuation than somewhere like Europe.

When assessing value across markets, we need to set a level playing field to overcome this issue. One way to do this is to assess if each market is more expensive or cheaper than it has been historically. If you are unsure as to your investments, speak to a financial adviser.

 

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