Equities have had an excellent run so far this year. European and US markets are up 10% alike (in domestic currency terms). However, if you had to look into specific industries you would find that the certain sector outperformed the market. For instance, the Nasdaq is up 20% year-to-date due to the positive rally we have seen in technology stocks.
But this rally did not start in 2017. Going back to the financial crisis in 2008 when the DAX (German market) fell by more than 50%, the index subsequently rallied 240% from its trough. And even if an investor held the DAX Index at the peak before the crash, the portfolio would still be up 60%!
Given the strong rally we have seen in equity markets over the years, the obvious question everyone is asking now is, whether or not this rally will continue.
Which markets are still attractive?
The current bull run in global equities is near the strongest we have seen in history, only surpassed by the tech bubble in duration, and the 1980s market in ferocity.
However, European equity valuations are only near the trough levels of 2003. Moreover, earnings outlook have been the most positive in nearly five years.
On the other hand, the situation is different for the US stock market, which appears to be pricier than the European one.
Today’s US Shiller PE of 30x has been exceeded only twice in history, the first being prior to the Great Depression of 1929 and the second being the tech bubble of 2000. However, high US valuations do not necessarily mean the market will correct itself. The Shiller PE went from 30x to 42x from 1997- 2000 before the tech market crash.
What is the Shiller PE?
The Shiller PE (also known as the P/E 10 ratio) is a valuation measure, generally applied to broad equity indices, that uses real per-share earnings over a 10-year period. The Shiller ratio uses smoothed real earnings to eliminate the fluctuations in net income caused by variations in profit margins over a typical business cycle.
A positive note on US equities
On a positive note for US equities, the high multiples on US stocks appear to be driven by traditional “acceptable” factors for investors. Essentially low and stable inflation, stable GDP growth, easy monetary policy and high profitability have historically translated to higher valuations.
Today, the variability in global growth and inflation is at a multi-decade low. Monetary policy, while less supportive now, is far from being restrictive. Profitability of US stocks is also near highs. Crucially, economists’ forecasts suggest this placid environment remains in 2018. Without a spike in inflation, or a fall in profitability, a significant change in US valuations appears unlikely.
Europe remains our top pick for equities
The factors mentioned above also help explain why Europe is significantly cheaper than the US. The key difference is profitability. However, with European profit margins now catching up to the US, our central scenario is for stability in the US, and continued acceleration in Europe.
Conclusion
Investors need to get exposure to the equity markets if they are counting on making a decent return in 2017.
With interest rates so low, returns from the bond market are limited. On the other hand, improved economic growth is contributing towards improved corporate financials and forecasts make equities an attractive asset class to consider.
Despite equity markets rallying strongly, we believe that there is still value out there. A well-diversified portfolio, which is focused on sectors which are expected to outperform in the current environment, should continue to reap rewards from the equity market.
Disclaimer:
This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.