Spotlight
Dancing on the ceiling?
With US growth strengthening and inflation creeping up
towards 2%, the end of the bond rally appears nigh. This leaves
equities with the potential for further gains in the second half
of 2014, but has the equity market become too expensive after
the bull run of the past few years?
So far in 2014, bond returns have surprised on the upside versus
market expectations. Government bond yields have fallen and
credit spreads narrowed further, driving a 4.9% return in global
investment grade bonds, not far short of the 6.6% return for global
equities (In USD terms). As we have argued in recent months,
we expect this rally in the bond market to come to an end as US
growth improves, inflation begins to move back towards 2% and
the US Federal Reserve’s quantitative easing program draws to a
close.
However, different measures offer up varying degrees of overvaluation for the US equity market:
• The trailing PE (price earnings) for the S&P 500 currently stands at
18.2x versus a five decade median of 17x
• The S&P 500 one year forward earnings PE is 15.9x versus a 30
year median of 14.3x
• The Cyclically Adjusted PE ratio, also known as the Shiller PE,
which uses a 10-year average of earnings to value the market,
gives a more worrisome picture, standing at 26.2x versus a five
decade median of 19.8x or 16x over the past century
Valuation measures suggest the US share market is over-valued
50
45
40
35
30
25
20
15
10
5
2011
2007
2004
2001
1997
1990
1987
1983
1980
1977
1973
1970
1966
1963
0
1960
When looking at the prospects for financial markets in the second
half of the year, along with the debate about the direction of
bonds, attention is increasingly focused on equity markets and
invariably, valuations. Not surprisingly, the US equity market gets
most of the attention given the high correlation of most developed
market equity markets to the S&P 500 and the strength of its rally
in the past five years.
Forward PE
Shiller PE
Trailing PE
Source: Datastream, Robert Shiller. ANZ Global Wealth. July 2014.
The report is published by ANZ Wealth Asia. All charts and tables are individually sourced. "ANZ analysts" refer to investment professionals within the ANZ CIO Office, ANZ Economics & Markets
Research and ANZ Wealth Asia. For more information, please contact your ANZ Relationship Manager.