An SG Research double bill today – on two big topics. First off are stockmarkets in a bubble, with the S&P 500 for instance up just a shade under 90% in less than 15 months. I think we’re not in a bubble though I think they look expensive. SG’s global strategists led by Arthur Van Slooten and colleagues agree. In a paper entitled “You think the Bubble is about to Burst? What Bubble? “ they say they cannot convince themselves “that the market is in Bubble territory just yet, let alone on the brink of an inevitable Bust. Indeed, we think several other, less-scary, scenarios could play out”. They look at a range of measures, all of which suggest some (varying) cause for concern but nothing indicating a bubble. These include:
Earnings: “IBES consensus earnings for the next 12 months stand at 16x P/E for European equities and 21x for US equities. Granted, this is well above the long-term average forward P/Es of 13.9x and 16.2x, respectively, but these multiples have remained remarkably stable over the last year.”
Valuations : “At 37x 10-year historical earnings, the current multiple is second only to the period just before the dot-com bubble Burst. But we still see no reason to run for the exit, given the trend in [lower interest rates and bond yields] – where just as remarkably, the 10-year UST yield has fallen from 15.1% in 1981 to 1.6% as of end-May 2021. This combination of CAPE and UST yield raise an important point, i.e., valuation levels are best gauged in the context of the current interest rate environment”.
Equity risk premium : “the ERP has dropped to 4.1%, just above its long-term average. The SG ERP matrix below signals 6.1% upside potential in the S&P 500 (4,202=>4,458) via a combination of a further drop in ERP and a further rise in bond yields”.
Fund flows : do look a bit closer to bubble territory “thanks to ‘excess’ household savings accumulated during extended lockdowns, net inflows into equity funds have been particularly strong of late…But more importantly, the strong equity performance we highlight above has led to a sharp increase in the weight of equities …”.
Investor positioning: The SG team uses an in house system called the Multi Asset Risk Indicator (see chart) which they suggest is “currently far removed from its upper bound, which marks the transition to investors becoming excessively risk-on – such as was the case in summer 2018. So again, no signs of exuberance in investor positioning currently, almost the contrary. Such remarkable constraint could reflect fear of a bumpy road to Fed QE tapering. If our reading is correct, then this threat has resulted in remarkable investor discipline”.
So, expensive yes, bubble now. “High valuations are more likely to induce some volatility and ‘routine’ corrections can never be ruled out. Hence, rather than positioning for a fearful Triple-B (Boom, Bubble, Bust) scenario, we favour a Triple-V scenario, i.e., a Virus, Vaccine, V-shaped recovery “.
SG teams have been on the ball recently, especially their Asian equity teams who’ve been wary of Chinese equities, especially tech stocks for some time. But now they’ve reversed that position, as part of their overall Asa Third Quarter forecasts. In “Asia Equity Outlook: Third Quarter” Frank Benzimra, Rajat Agarwal and Makhdoom Muteeb Raina announce that they’ve come full and reckon its time to reposition on Chinese equities, after correctly calling the pause overall on the region, the outperformance of East (Korea and Taiwan) and the underperformance of South (EM ASEAN) – although they admit they missed the second leg of the internet sell-off, despite being long HSI/Short HS Tech. Here’s their very useful projections for the next quarter in Asia:
– “The pause continues. The best of the reflation trade is behind us: the earnings momentum is softening and valuations leave little room for rerating. The upside will come from lesser headwinds from currency and yields.
– China equities correction is overdone. Equity markets have started to price-in the regulatory and deleveraging risks
– . The other headwind, rising economic tensions with the US, mostly impact equities through tariff hikes. Three sectors we like: banks, internet and green stocks.
– The euphoria will not last forever in Taiwan. Taiwan, but also Korea equities have benefitted from front loading growth and valuation re-rating in a context of accelerating growth. The fundamentals are now stretched with equity risk premium at a decade low. We turn Neutral.
– After the underperformance, we have a 10% upside for Japan. The positive catalysts to watch include a return of the Value style with economies reopening, an acceleration in the vaccination roll-out and, longer term, a Green capex boom.
– South Asia is an underweight. High earnings expectations and rich valuations leave little upside for India equities, mostly a micro story. We turn underweight. The stance on emerging ASEAN remains negative on borders not expected to open soon.
– The rotation from Tech Hardware to internet is underway. China Internet valuation has reverted to its 2Q 2014 level and the regulatory tightening starts to be better understood. In the Big Tech Asia space, the risk reward has shifted from Tech Hardware to China Internet
– The Asia Green transition stocks are aligned with long term policy agenda. The 1Q correction has sent valuations of China Green stocks back to more compelling levels. “