DAILY SKETCH - Rational bubble

    • Daily sketch

In recent days, the media has become increasingly aware that the current situation in global stock markets could be described as a "rational bubble". Labeled "bubble" due to the fact that the current valuation of global stock markets is extremely high close to all-time highs. For example, according to our proprietary valuation model, which is based on P/E, P/B and P/S, the broadest global equity index MSCI All Country World is currently overvalued by approximately 50%. After all, the current value of global P/E is an extreme 33. According to classical valuation indicators, global stock markets are therefore very expensive, i.e. it is a "bubble".

DAILY SKETCH - Rational bubble

According to some investment experts, the addition of "rational" to the label bubble occurs because, due to the unprecedented quantitative easing or money printing of key central banks, equity valuations are not so high. For example, we work with an indicator that measures the global stock market capitalization with the global money supply. The value of this indicator is currently 111% and is only slightly above the long-term historical average. So if we take into account the amount of money that circulates in the global financial system, global stock markets may not seem expensive, i.e. the addition of "rational" to the label bubble.

What conclusion can we draw from this analysis? In our opinion, the truth is somewhere in the middle. According to traditional valuation indicators such as P/E, global stock markets are extremely expensive, driven by unprecedented valuations of US stocks. On the other hand, there is also the undeniable fact that quantitative easing helps financial markets very strongly. By buying on the secondary markets, central banks support the market prices of bonds, which at the same time reduces the required bond yields until maturity. At the same time, they are currently at a record low, when the average global bond yield to maturity is only 0.9%. Record low bond yields to maturity in turn increase the fundamental intrinsic value of stocks because, ceteris paribus, if we discount the future expected cash flows that companies generate at lower interest rates, we get significantly higher estimates of fundamental intrinsic values. Therefore current record classical valuation indicators such as P/E may not be so exaggerated, given the global money supply, although in any case they are now extremely high.

In any case, in our opinion, global stock valuations are certainly not low. Therefore, the implied average expected annual equity returns over the medium term of the next five are quite low. After all, we reflect this fact in our global equity allocation, in which we have a portfolio in the global equity component underweighted against benchmarks. We believe that some market correction in the coming weeks and months could certainly come. If that happened, we would probably use the correction to increase the global equity component and improve our global equity outlook.
Michal Stupavský
Investment Strategist at Conseq Investment Management, a.s.

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