Perspective

Why I can stomach higher equity valuations


The rising involvement of retail investors has been an intriguing trend during the pandemic, culminating in the surge and slump of GameStop shares.

As an industry, we worry about the disconnection of individual investors from financial markets, the hubs of wealth creation. Direct ownership of shares by individuals has been declining for decades. For that reason, the growing fervour for stock investing that had been growing throughout 2020 should be welcomed. The more recent encouragement of novice investors to buy wildly inflated stocks, however, should not.

For many, GameStop shares will be the one and only time they buy a stock, left only with a memory of their part in the “angry bubble” and a stinging loss. I worry about the risks being taken at a time when wealth and health is already a pressing concern.

We have seen retail investor exuberance pervade markets before. Back in January 2000, working as a young analyst I was among the buyers of tech start-ups. It’s easy for new investors to be engulfed by speculative fever.

The rise of the lockdown investor has been explored in this column before with our observations on the growth of the Robinhood trading platform during lockdown 1. But then, as now, my focus was on valuations and the other critical factors driving markets.

Our expectation that vaccines would provide a shot in the arm for recovery stocks has proven so. Markets have risen quite a way since then and, as we pointed out last month, valuations for major markets look expensive against historic norms. [See below, with detailed descriptions of the metrics used here].

The key below the chart explains which colour denotes how expensive the market is compared to its history over the last 15 years. So the darkest red blocks show that on that particular valuation measure, the market is 20% more expensive than the median of the past 15 years. The green shows which markets are 0 – 10% cheaper than the median of the past 15 years.

Stock-market-valuations.png

But it’s not reason to stop believing in equities.

As we struggle with home-schooling and dark days, it is easy to feel dejected. However, work by our Data Insights Unit suggests that we should start to see the benefit of vaccines in the US and the UK as we move into the spring. Green shoots are beginning to emerge and central banks will not want them to be trampled by tightening monetary policy.

Quite simply, the sheer scale of economic stress created by lockdowns makes the unwinding of stimulus measures unlikely, a view reinforced by the Federal Reserve last month.

This leaves us to ponder a scenario where economies recover and bond yields stay low, which helps to underpin equity valuations. Markets feel bubbly but bubbles tend to get pricked by higher rates. For now the central bankers are keeping their needles safely tucked away.

What about inflation? There’s much talk of the Roaring Twenties and the subsequent price pressure that could ensue. But it’s too early to be concerned. There is little evidence of dangerous inflationary pressure. In fact, a little inflation would support the story of global recovery yet wouldn’t be enough to prompt central banks to raise rates.

I can therefore stomach the risk of higher valuations in equities. As we lift our heads and move into spring, the news on the virus may continue to improve. At that point it might be time to take some profits and enjoy a little sunshine.  

 

Important information

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.

This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. 

Finally, investors should always be mindful that past performance and historic market patterns are not a reliable guide to the future and that your money is at risk, as is this case with any investment.

For Accredited Investors Only. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument and is not intended to provide and should not be relied upon for accounting, legal or tax advice, or investment recommendations.

The information in this market outlook is derived from sources which we consider to be reliable. However, it may not in all cases be verified independently and we do not attest to its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Forecasts may be the consensus of extremely divergent possibilities and the full range of potential outcomes should be appreciated. No representation or warranty is made that any value (or proximity to) any value, return or forecast will be achieved. The opinions expressed are those of employees of Schroder & Co. (Asia) Limited, and reflect their judgement at this date and are subject to change. Reliance should not be placed on the views and information in this market outlook when taking individual investment and/or strategic decisions. 

No part of this document may be reproduced in any manner without the prior written permission of Schroder & Co. (Asia) Limited.

Contact Schroders Wealth Management

To discuss your wealth management requirements, or to find out more about our services, please contact:

Jasper Lai

Jasper Lai

Head of Client Advisory, Asia
Telephone:
jasper.lai@schroders.com