Global eq­ui­ties re­main un­der­val­ued

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Even though Wall Street is within a whisker of its record high and mar­ket vo­latil­ity is close to its low­est level since the balmy pre-cri­sis days of early 2007, many in­vestors have de­cided to worry rather than to re­joice. The cur­rent bull mar­ket is unloved. Doubters com­plain that it has been driven ar­ti­fi­cially by liq­uid­ity and by a des­per­ate and dan­ger­ous hunt for yield. The eco­nomic ‘re­al­i­ties’, they ar­gue, jus­tify a far more mod­est per­for­mance. Of course a mar­ket cor­rec­tion could oc­cur at any time. But fun­da­men­tally we dis­agree with the skep­tics’ view. To see why, let’s ex­am­ine some ba­sic arith­metic.

Look­ing glob­ally, far from be­hav­ing ex­u­ber­antly, eq­uity prices re­main in their post-trau­matic re­cov­ery mode. To date, 1730 work­ing days have passed with­out the MSCI world ‘all coun­try’ in­dex set­ting a new high in US dol­lar terms. Ad­mit­tedly, mar­kets are very close to break­ing out of this rut, as the world in­dex now stands only a hair’s breadth be­low the high of 428.63 it reached on the Novem­ber 1, 2007. Still, they are not there yet, and it has taken them a long time to get this far. Since 1970, when the MSCI in­dex se­ries starts, fi­nan­cial mar­kets have ex­pe­ri­enced only two other com­pa­ra­bly long pe­ri­ods in which global stock prices failed to make new highs: 1749 days from Jan­uary 1973 to Septem­ber 1979, and 1716 days from March 2000 to Oc­to­ber 2006. Ex­clud­ing these post­trau­matic pe­ri­ods, on aver­age it has taken only six months be­fore world stock prices make new highs. In other words, set­ting new highs should be busi­ness as usual.

Hap­pily for the world-and in sharp con­trast to eq­uity mar­kets-over most of that 1730 work­ing day pe­riod, global nom­i­nal GDP in US dol­lars has con­tin­ued to set new highs (the ex­cep­tion, of course, was in 2009). Apart from a few fringe pro­po­nents of “de­growth”, no­body is com­plain­ing, far less wor­ry­ing, about this. Af­ter the 2009 re­ces­sion it took only one year for global GDP to break through its 2008 high. Led first by the BRICs, then by the An­glo-Saxon economies, and now even by parts of Europe, since Oc­to­ber 2007 global nom­i­nal GDP has in­creased by +33% (or al­most $20trn). In the mean­time, global eq­uity prices have stag­nated.

These sim­ple facts lead us to the “macro P/E” of world eq­uity mar­kets, that is, the ra­tio of global eq­uity prices to global GDP. This mea­sure of global eq­uity val­u­a­tion has im­proved sig­nif­i­cantly since 2009. But at -13% be­low its long-term aver­age, it re­mains in low-ly­ing ter­ri­tory. As we know, his­tory is not an in­fal­li­ble guide, but it is still worth not­ing that just be­fore the crash of Oc­to­ber 1987 the global macro P/E was al­most 40% higher than it is now, and in June 1998 it was 55% higher. As­sum­ing a mod­est 5% nom­i­nal growth rate for global GDP over the com­ing years, and a mere re­turn to mean for the macro P/E by 2018, then over the next four years world eq­ui­ties will rise by 8.7% per year. So, rather than be­ing ar­ti­fi­cially strong, as the bears ar­gue, it ap­pears that world eq­uity mar­kets re­main weak rel­a­tive to global eco­nomic fun­da­men­tals, as they have sub­stan­tially un­der­shot ac­cu­mu­lated GDP growth since 2007. If some­thing has to cor­rect, there­fore, it is not the price of global eq­ui­ties, but rather the re­gional dis­tri­bu­tion of the bull mar­ket, which so far has been ex­traor­di­nar­ily US-cen­tric.

Al­though Wall Street is now 25% above its 2007 high, the rest of the world re­mains -20% be­low! How­ever, with more ag­gres­sive cen­tral banks in Europe and Ja­pan, and less down­ward pres­sure on emerg­ing economies, we are tempted to be­lieve that a broader, more bal­anced bull mar­ket may fi­nally be in the off­ing.

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