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Equities: the main US market is back to its historical high!

  • The fears of the start of the year have been erased

After the concerns that prevailed at the start of the year (slump in the RMB, concerns over China), the equities markets regained their bull trend just before mid-February. Some of them were able to erase January’s poor performance, specifically the US market. The markets benefited from two growth drivers: the turnaround in oil prices (Brent has risen from $27 to $43 per barrel since the end of January) and the weakening of the dollar, in particular following March’s FOMC meeting when the Fed showed that it was determined to remain accommodating over a longer timeframe. The US ISM Manufacturing Index moved back above 50 and, recently, Chinese statistics (GDP, industrial output, external trade, money supply) have reassured the markets over China’s capacity to “manage” the soft landing of its economic growth.

  • The US market mitigated the fall and then rebounded strongly

The market PER fell from its 18x 12-month trailing earnings to less than 16x, before returning to its starting point. As such, there is a perennial relationship through time between inflation and PER levels (see chart). The markets earn the most when inflation is slightly positive (between 0% and 3%). If inflation increases or falls into negative territory from these levels, the PER level falls. This is exactly what happened at the beginning of the year. The 18x level is perfectly in line with the historic average for a perfect inflation regime (between 0% and 3%). Deflationary risks then drove the PER downwards. Finally, when these risks dissipated, we returned to square one.

  • What does this mean for the future?

Exceeding the 18x 12-month trailing earnings level would mean being back in upside exaggeration territory in terms of valuation. Unless of course profits were to rise thanks to an improvement in nominal GDP growth. During the oil countershock of 1987, margins that were declining managed to rebound. However, we remain cautious about this possibility as wages are beginning to recover. Whatever the case, the US market valuation currently seems very high compared to other markets. A combination of the S&P500’s PER and PBV relative to the MSCI World comes out to more than one standard deviation above the average for the last ten years, which leaves room for a catch-up (in relative terms) in the other markets, in particular the emerging markets and the Eurozone.

In 2016, the markets have become decidedly more tactical than directional.

 

 

 

2016-04-22-focus
Eric MIJOT, Strategy and Economic Research at Amundi
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Equities: the main US market is back to its historical high!
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