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CAZENOVE CAPITAL’S PETER HILLIER JOINS US TO ANSWER A QUESTION ABOUT INVESTMENT
The strong performance of gold and government bonds this year is a clear indication that investors are anxious. These assets tend to do well when prospects for the global economy are precarious. However, if investors really are worried about the outlook, why are global stock prices still trading near all-time highs – and with valuations at their highest level in years? At first glance, stocks don’t look cheap. Global equities trade at just over 16 times forecast earnings over the next year, near the highest level we have seen since 2004.
Not all stocks are expensive
There is a wide variation in the valuation of different sectors. Investors are paying very high multiples for defensive sectors – such as consumer staples. The same is true for growth companies that can continue increasing sales whatever happens in the broader economy – such as technology giant Amazon. By contrast, sectors that are most exposed to the business cycle – such as energy and financials – trade at much lower valuations. The disconnect is the widest it has been in years.
Valuations supported by healthy profitability and low inflation
While stock markets look somewhat expensive relative to history, there are reasons why valuations should be a bit higher than average. One reason is profitability. When companies are generating high profits, they are better placed to cope with a tougher economy and invest in new business opportunities. US companies, in particular, find themselves in this situation today, and they are being rewarded with higher valuation multiples. Another reason is inflation. Valuations tend to be highest when inflation is low and stable, as is the case today, as companies have scope to increase prices without seeing their costs spiral out of control.
Anxiety is definitely present, with political and economic change adding to uncertainty. Yet while valuations are above their long-term average, they do not appear irrational.