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Marcuard's Market update by GaveKal Dragonomics
Even though Wall Street is within a whisker of its record high and market volatility is close to its lowest level since the balmy pre-crisis days of early 2007, many investors have decided to worry rather than to rejoice. The current bull market is unloved. Doubters complain that it has been driven artificially by liquidity and by a desperate and dangerous hunt for yield. The economic ‘realities’, they argue, justify a far more modest performance. Of course a market correction could occur at any time. But fundamentally we disagree with the skeptics’ view. To see why, let’s examine some basic arithmetic.
Looking globally, far from behaving exuberantly, equity prices remain in their post-traumatic recovery mode. To date, 1730 working days have passed without the MSCI world ‘all country’ index setting a new high in US dollar terms. Admittedly, markets are very close to breaking out of this rut, as the world index now stands only a hair’s breadth below the high of 428.63 it reached on the November 1, 2007. Still, they are not there yet, and it has taken them a long time to get this far. Since 1970, when the MSCI index series starts, financial markets have experienced only two other comparably long periods in which global stock prices failed to make new highs: 1749 days from January 1973 to September 1979, and 1716 days from March 2000 to October 2006. Excluding these post-traumatic periods, on average it has taken only six months before world stock prices make new highs. In other words, setting new highs should be business as usual.
Happily for the world—and in sharp contrast to equity markets—over most of that 1730 working day period, global nominal GDP in US dollars has continued to set new highs (the exception, of course, was in 2009). Apart from a few fringe proponents of “degrowth”, nobody is complaining, far less worrying, about this. After the 2009 recession it took only one year for global GDP to break through its 2008 high. Led first by the BRICs, then by the Anglo-Saxon economies, and now even by parts of Europe, since October 2007 global nominal GDP has increased by +33% (or almost $20trn). In the meantime, global equity prices have stagnated.
These simple facts lead us to the “macro P/E” of world equity markets, that is, the ratio of global equity prices to global GDP. This measure of global equity valuation has improved significantly since 2009. But at -13% below its long-term average, it remains in low-lying territory. As we know, history is not an infallible guide, but it is still worth noting that just before the crash of October 1987 the global macro P/E was almost 40% higher than it is now, and in June 1998 it was 55% higher. Assuming a modest 5% nominal growth rate for global GDP over the coming years, and a mere return to mean for the macro P/E by 2018, then over the next four years world equities will rise by 8.7% per year.
So, rather than being artificially strong, as the bears argue, it appears that world equity markets remain weak relative to global economic fundamentals, as they have substantially undershot accumulated GDP growth since 2007. If something has to correct, therefore, it is not the price of global equities, but rather the regional distribution of the bull market, which so far has been extraordinarily US-centric.
Although Wall Street is now 25% above its 2007 high, the rest of the world remains -20% below! However, with more aggressive central banks in Europe and Japan, and less downward pressure on emerging economies, we are tempted to believe that a broader, more balanced bull market may finally be in the offing.
