The U.S. 10-year yield continued to recover from recent lows despite mixed economic data during the week and Jerome Powell, the Federal Reserve President, reiterating his dovish stance on the future evolution of U.S. monetary policy. U.S economic observers are finding it more difficult than ever (it is never easy) to estimate the sustainable course of the economic recovery in the context of the fusion of so many unprecedented events. However, U.S. yields holding above recent lows does indicate that though short-term data may fall short of best estimates, a genuine growth scare is still unwarranted (chart below). Covid flare ups and persistent supply-side shortages are inhibiting growth, but they are not derailing it
Source: Bloomberg Finance
Europe remains in a better phase of recovery
As we have pointed out before, Europe remains in a better phase of its economic recovery journey despite also sharing the impact of concerns over the spread of the Delta variant and supply-side shortages. Consumer confidence (chart below), the Services PMI, and the Manufacturing PMI all slipped in August, but remain very near their recent highs.
Source: Strategas Research Partners
In our last update we did highlight the importance of closely monitoring the recent pick-up in high yield spreads which can be an early indication of building financial stress. However, spreads do remain well-behaved and did retrace some of the recent increase during the past week (chart below)
Source: Bloomberg Finance
In addition, we took a closer look as to specific sector influences on the recent spread increase to determine if there were any clues as to the importance we should attach to the recent rise. Looking at high yield spreads by sector shows that the Energy and Utility sectors are the two most notably off their lows (chart below). All other sectors remain extremely close to their one-year lows. Energy sector spreads bottomed on July 1st , which is around the time that oil prices peaked this year. However, should oil prices recover, spreads will likely compress back to the lows all else being equal. The point is that the recent rise appears more sector specific rather than revealing rising investor concerns over a general economic slowdown.
Source: Strategas Research Partners
Valuation has always remained at the core of our investment approach, and we think it useful to provide a general market valuation update as we enter the final third of the year. The chart below, while updated from when last we reproduced it, still shows the U.S. equity market to be significantly overvalued based on its historical ranges whatever the valuation metric employed.
Source: Strategas Research Partners
However, it must be recognised that the above valuation ranges were recorded when interest rates were considerably higher. To quote a U.S. market strategist that we follow closely, Jason Trennert “interest rates in the financial world are what gravity is in the physical world. To the extent to which 10-year Treasury yields have averaged 5% since 1950 and now stand at a paltry 1.25%, stock prices have achieved a certain weightlessness that seems otherworldly.” As long as we remain in a world of zero bound interest rates then the lack of investment alternatives to equites will most probably keep the asset class overvalued. Indeed, as the chart below shows, compared to common investment alternatives of fixed income and residential real estate, equities remain the least overvalued asset class.
Source: Strategas Research Partners
Gezien het huidige waarderingsrisico van de aandelenmarkten leert de ervaring dat er onder de oppervlakte altijd wel enige beleggingskans schuilt. Hoewel de index dus duur lijkt, biedt een uitsplitsing per sector, zoals hieronder wordt gepresenteerd, enkele verleidelijke sectorale kansen die verder moeten worden onderzocht. Twee snelle observaties die uit een blik op de tabel naar voren komen. Ten eerste, zoals blijkt uit de eerste helft van de tabel (eerste 3 kolommen), is Energie de enige sector die momenteel wordt verkocht tegen een korting ten opzichte van zijn gemiddelde winstmultiplicatie over 15 jaar. Aan het andere uiteinde van de tabel is te zien dat de technologiesector momenteel wordt verkocht tegen een premie van 64% ten opzichte van zijn gemiddelde over 15 jaar. De tweede helft van de tabel bekijkt de waardering van de sector in verhouding tot die van de algemene markt. Hieruit blijkt opnieuw dat er slechts drie sectoren zijn die met een noemenswaardige korting (>20%) op de markt staan – Financials, Materials en Energy. Ironisch genoeg zijn dit de drie sectoren die in 2021 de grootste winstgroei van de markt lieten optekenen en die naar verwachting in 2022 zal aanhouden.
Source: Strategas Research Partners
An updated chart (below) of the relative valuation of the most expensive (Growth) versus the least expensive (Value) stocks in the market would show that the valuation discrepancy has actually continued to widen even as Value stocks have enjoyed strong absolute returns in 2021. This is simply because Value stocks have also posted the strongest earnings growth which so far has not been fully appreciated by investors. As such, the investment attraction of Value has increased during the year as its relative valuation has become even cheaper at a time when earnings growth looks set to continue into 2022.
Source: Strategas Research Partners
