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So much for selling in May. Major markets have been on a roll since then, with America’s S&P 500 up 6% to a four-year high and the FTSE 100 ahead by over 10% to a 44-month peak. UK stocks have been helped by a strong performance from the heavyweight oil sector amid record oil prices, while a robust global economy and a slide in the pound have also buoyed earnings and sentiment.
But can the run last much longer? With consumption weakening and house prices falling, the economic outlook is darkening, and investors can’t count on another interest rate cut with producers’ raw material costs climbing at their fastest annual rate in 20 years.
Meanwhile, Chris Brown-Humes in the FT notes that the FTSE 100 is on a PE of almost 15, around the long-term average. The FTSE All-Share’s 3% dividend yield isn’t exactly compelling either, says RH Asset Management’s Onassis newsletter. For excellent long-term returns, the right starting point is 6%. All in all, as Martin Flanagan put it in The Scotsman, the market lacks a “growth story”.
The US markets don’t have much to look forward to either. All the excitement about companies beating their second-quarter earnings forecasts is a reflection of expectations management rather than healthy profits: earnings growth has slowed to 11%, compared to last year’s 20%.
This trend is set to endure, says Gary Shilling in Forbes. The expansion is long in the tooth – it’s two months longer than the average since 1950 – and energy prices will soon begin to depress growth. With excess global capacity crimping capital spending, the economy depends on consumption, underpinned by borrowing against unsustainable house price rises. “When, not if” this bubble bursts, the 20-year borrowing and spending binge will come to an end.
Note too that US stocks are still far too expensive. James Montier of Dresdner Kleinwort Wasserstein notes that the PE for US stocks based on forward operating earnings–in any case based on forecasts from “cheerleading analysts”–is at 16, while the long-run average for this measure is 12.5. Eight other measures, including cyclically-adjusted PEs and price to-book, all point the same way: the average overvaluation suggested by the nine measures is 59%. That, says Philip Coggan in the FT, is something to bear in mind “before getting too bullish about global stock markets”
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Andrew Van Sickle
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