Apr 01 2008
Are equities cheap?
Equity and Bond investments relative value
Equities (as at 31/3/2008)
|
Equities |
Level |
Change YTD |
Div Yield |
P/E
|
|
ISEQ |
6153 |
-11.3% |
3.3% |
7.0 |
|
FTSE100 |
5693 |
-11.8% |
4.3% |
11.4 |
|
S&P 500 |
1315 |
-10.4% |
2.3% |
19.9 |
|
EuroStoxx 50 |
3030 |
-17.8% |
4.5% |
10.3 |
|
Nikkei 225 |
12800 |
-16.3% |
1.7% |
14.2 |
Source: Dolmen Securities Ltd
Are equities cheap?
The P/E ratio of equity markets should be an indicator of fair market value.
For example:
The FTSE 100 passed 6500 on 16th April 2007, passing the level of the 14th September 2000.
On the way up, the FTSE reached 6500 in April 1999 at a price/earnings ratio of over 28.
On the 17th April 2007 the PE ratio was around 13.
The long term PE for the FTSE 100 over the last 20 years is 23.
So, surely at these levels, equities must represent good value?
One needs to factor in that the current price earnings ratio is based on previous years’ profits and that if one projects falling profits in the future (due to recession) then the relative value of equities is much less attractive.
Bonds
The yield on the US 10-year treasury is 3.50% while the German equivalent is 3.93%.
US T Bills have been described as currently offering a “return free risk” due to currency and inflation risks so you would have to be as mad as a “box of hot frogs” to even consider them.
Equally, with deposit rates of up to 5% Gross available to Euro Investors and over 6% for Sterling Investors, Bonds still look expensive relative to cash at the short end.
The current yield on 10 year UK Government Bonds is 4.37% almost exactly matching the yield on the FTSE 100. The same occurred in early 2003 as equity market dividend yields rose to those of 10 year bond yields and marked a reversal in equity declines as investors became less panicky about war, recession and earnings.
UK Government Bonds
Source: Bloomberg
Conclusions
Historically, equities are not “expensive”……but this is in the context of the last 20 years which has seen spectacular returns from the markets.
Bonds are expensive relative to deposits and with yields from equities close to those from 10 year bonds, investors would normally be buying equities.
However, current market conditions are far from normal and we may not be out of the woods yet. Remember:
“Markets can remain irrational longer than you can remain solvent.” — John Maynard Keynes
