One of the world’s top sharemarket strategists thinks that the ongoing bull market is one of the most “bearish” ever, but it’s only mounting levels of leverage, not valuations, that look remotely sinister.
Global equities are trading at between 20 and 21 times forecast earnings, mostly because US stocks are trading at 23 to 24 times, and that is “starting to get a bit rich”, according to Robert Buckland, the London-based global equity strategist for Citigroup. “Are they off the scale, 2000-style? No.”
Indeed, valuations were 50 per cent higher then.
“Yes, valuations are looking rich, definitely the richest that they’ve been in this cycle, nobody’s going to deny that,” the strategist said. “But relative to the previous mega-bubble, particularly in 2000, you probably need to see the market go up another 50 to 100 per cent to see it valued in the way that it was back then.”
A fund manager’s definition of a bubble is “something I’d get fired for not owning”, he said.
Mr Buckland observed that, compared to previous descents into bear territory, current conditions lack many of the indicators of an overstretched market.
However, net debt-to-EBITDA, a measure of the indebtedness of the corporate sector in the US, is a source of apparent concern because the health of balance sheets is deteriorating as leverage rises. The metric is at 1.6 times, versus 1.4 times in October 2007 and 1.8 times in March 2000.
“US companies have been borrowing money, as you know, to buy back shares, and they’ve been borrowing money to bid for each other,” he said.
While that was not the intention behind central bank stimulus, “a bunch of very cheap money has been thrown at them by central banks and they’ve been using that money to gear up their balance sheets”.
The level of leverage is one of the strategist’s most acute concerns.
“The interesting thing is you would expect the main policeman of leverage should be the credit market. The credit market is the market that lends capital to companies and you would think they would be quite sensitive to the fact that the guys they’re lending money to are getting worse credits,” Mr Buckland said. Not so.
“The cost of credit is super cheap for companies and credit investors are not exacting a particularly high interest charge on top of government bond yields for leveraged companies to borrow. That could be a source of concern. That was certainly an area that wobbled very nastily back in January and February of last year.”
Central banks pulling away from monetary stimulus, led by the Federal Reserve, could be a trigger for equity market weakness.
Leveraged corporate sector
“I think that could produce a 10 per cent correction, something like that, but I’d buy that [dip] as opposed to selling it.”
The strategist also put forward the theory that the market’s favoured measure of volatility, the Vix, was not an effective predictor of performance.
“At the moment we’re getting a low Vix and we’re getting low credit spreads; what worries me about low credit spreads is we’ve got a relatively leveraged corporate sector right now,” he said.
The reach for yield might explain why credit markets are so sanguine. “The risk is that spreads suddenly gap out, and that takes the Vix with it.”
The Vix is not a good predictor of future stock market performance, he said, although it may be being used somewhat bizarrely as a traded asset.
“If you’re brave enough to buy the Vix when it’s 60, you make big money,” he said. But, “you can’t actually define whether you’re going to get negative or positive returns when you buy the Vix at low levels.”