Chart of the Week: Equity Valuations Look Like They Have Landed in the Bargain Basement
Risk aversion by investors has left some global market valuations at very cheap levels.
U.S. stocks experienced their best week so far in 2012 last week, a welcome relief for investors fed up the fact that the indicator signaling whether global financial markets are in “risk on” or “risk off” mode has been stuck firmly in the “risk off” position since the end of the first quarter. The Dow Jones Industrial Average wrapped up last Friday’s blockbuster trading session with a 3.6% gain for the week, while the S&P 500 rose 3.5%. Still, while that rally was greeted with delight by investors who had seen their gains for the year wiped out during the five previous weeks, uncertainty and anxiety remain.
So, too, do low valuations, as this week’s Chart of the Week (below) clearly demonstrates. One of the most richly priced equity markets today – that of Mexico – trades at 15.4 times its estimated12-month forward earnings. In contrast to most other equity markets, it also is trading above its 10-year average P/E ratio, while countries such as Japan, Germany, the United Kingdom, Russia and Italy command valuations today that are closer to their respective 10-year lows.
Many pundits argue that the reason for these bargain-basement level valuations lies in the uncertainty surrounding the macroeconomic picture. Certainly, there are some important causes for concern that have become perennial features begun to feel like a permanent blot on the investment landscape. While the weekend bailout of Spain’s banking system by its Eurozone partners may alleviate some concerns about that country’s immediate future, there is still next week’s Greek election to navigate, meaning that investors may continue to view euro-denominated assets with unease or fear in the coming weeks. And it’s impossible to gauge the impact of events in Greece – up to and including the country’s exit from the Eurozone – on the global economy or stock valuations. Add ever-present fears about whether China’s economy might be in for a bumpier landing than expected and you have a recipe for risk aversion on the part of equity investors.
Interest rates in the United States and Germany are at such astonishingly low levels that it may be impossible for investors not to contemplate re-allocating some cash into the very cheap world of equities, as we saw last week. But it may take many more weeks of that kind of valuation discrepancy, coupled with strong fundamental news (such as better than expected earnings announcements at the end of the second quarter) and an absence of anxiety-generating headlines, to propel stock market valuations toward their 10-year highs once more.