Coronavirus is not going away any time soon. Rising infection rates and expectations that a vaccine is moving deeper into 2021 is currently a positive for markets because it means that central bank and fiscal support will continue, ensuring low rates and wage subsidies.
And the absence of political appetite for harsh lockdowns means the spreading virus will not upset the shift in profits towards companies that offer class leading e-commerce platforms, those that provide the backbone for cloud computing, home renovation and furnishing products and those that facilitate domestic travel.
The continuing spread of the virus also ensures a world of low growth, so those companies that can demonstrate impressive growth rates will be highly prized.
Then, of course, if an effective vaccine is developed, investors will seek to own those companies that have hitherto been trampled by the hard economic stop. Travel-related companies such as airports, cruise lines and airports will, thanks to pent-up demand, be the most leveraged to a reopening of the economy.
With that in mind it is worth considering which markets, if any, are relatively cheap when compared to each other or to history.
On that front Schroders UK head of research and analytics Duncan Lamont tabled a handy comparison of markets using conventional market value metrics such as price to earnings (P/E) and price to book (P/B) ratios.
Lamont’s first observation is that the ratios used to determine “value” are conventional ratios such as P/E and P/B. These have limits in terms of their ability to determine value.
A company with a high P/E may not be expensive at all and may in fact be cheap if it is growing very quickly, while a company whose shares are trading on a low P/E may be expensive if, for example, it is about to enter bankruptcy.
The P/B ratio is understandably high for the US market because the most successful companies today such as Facebook, Google and Microsoft have relatively little in the way of “book value”. They don’t have much in tangible assets relative to their sales and profits.
Turning to the CAPE ratio (Robert Shiller’s cyclically adjusted price to earnings), it does suggest the market is relatively expensive, but Shiller himself notes that a high ratio does not translate to certainty about a crash; instead it implies low annual returns for the next decade.
Keep in mind the US market is responsible for 60 per cent of global markets by weight and it is therefore essential investors have a read on the extent of any overvaluation there.
It is also important that some of the companies with the scarcest qualities such as monopoly pricing power and growth are also listed in the US.
Further it should be noted that the FAAMG stocks (Facebook, Amazon, Apple, Microsoft and Google) have all become significantly more profitable as they have grown. Without exception their returns on equity are all higher today than they were just five years ago. Not only are they growing fast but they are become more valuable even faster.
Finally, it is worth remembering the negative interest rate narrative. Rates are already negative in several jurisdictions and should negative rates become a broader fixture it will increase the urgency with which investors seek positive returns from other asset classes, potentially driving stock prices even higher.
Equities represent the growth part of an investor portfolio and so the market could become even more skewed in its profile with investors demanding only the highest-quality growth companies.
If you aren’t convinced about the effectiveness of the negative-rate transmission mechanism, just imagine your banks tell you will now be paying them to keep your money on deposit. What would you do if you knew that your term deposit would be absolutely lower at the end of 90 days and that the longer you keep your money in the bank the lower it would go?
There is little doubt the coronavirus is out of control, and in the absence of a vaccine we are unlikely to return to the aggregate economic conditions of 2019 any time soon.
Rates and fiscal policy will remain accommodative and investors may have to continue buying the best growth companies.
Roger Montgomery is the founder and chief investment officer at www.montinvest.com
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