Do equities represent decent value? The key bullish point for me is the US economy, which is still in good shape. I’d also bet that the US Federal Reserve is likely to blink before thrusting the US into a slowdown. The Asian central banks, and especially the PBoC are also likely to get more active in 2019, and thus we could see a recovery in sentiment.
The big graphic below is from the Cross Asset research team at Morgan Stanley and acts as a nice summary of where valuations are at the moment. All things being equal – a very dangerous phrase I admit – global equities look much cheaper although corporate credit arguably looks less enticing. The stand out statistic is that the all-world MSCI index is trading on a forward PE of 12.9, well down on this time last year when it was at 16.7 times earnings – Morgan Stanley analysts reckon “cheap” on a twenty-year time frame is around 11 times forward earnings.
The problem of course with being mildly positive is that it’s currently hard to see any obvious positive catalysts apart from the abject surrender of the US Federal Reserve and its policy of ‘normalisation’. On that subject, my best guess is that we’ll probably see two more rounds of interest rate increases and then the Fed will stop and watch and wait. Maybe a massive stimulus by the PBoC might be the thing that’s needed for the global economy to pick up the pace. I would also argue that cheaper oil is also a much-needed tonic and in the UK we may even start to adjust to a post-Brexit future (or at least that’s the hope by mid-summer). So, there are reasons to be moderately cheerful, even if we are late in the global business cycle.
But there’s a catch. Any upside potential is unlikely to be huge and the downside risks as we peer into 2020 and 2021 are obvious and hard to miss – too much global debt, greater risk of a US/China confrontation, Eurozone wobbles. One last hurrah perhaps?
All of this ignores another fact. That we live in a low rates environment, whether we like it or not. And in that low rates environment, equities are seen as a decent source of income return i.e the scramble for yield has turned many equities into bond surrogates. The chart below – which I admit is a tad familiar – I think tells the single greatest story of the last decade, namely the compression of yields. The chart itself comes from the latest updated Income investing research pack by French bank SocGen, and their quant team.
The only fly in the ointment, of course, is the line which shows cash, where the yield (in the US at least) is rising. I’ve also noticed that the UK savings rate on the High Street has become much more competitive since the emergence of Marcus, Goldman Sachs online bank. It’s not uncommon now to find instant and short term dated accounts offering between 10.25 and 1.75% with fixed rate products above this level. Once we see cash rates move above 3% – a long way away from where we are now – maybe we could see a new structural shift back towards risk-free assets. But for now, the scramble for yield remains a priority for many investors and that might help underpin some equity valuations.