Equities reach record levels - What's next?
At the end of the first quarter of 2024, equity indices in the US and Europe reached new all-time highs. After a strong final spurt in the fourth quarter of 2023, the positive trend in equities continued with undiminished momentum. Due to the current consolidation at an elevated level, investors are asking themselves how the further development of equities should be assessed. Our fact-based analysis explains.
Development of equity prices (global)
After bad (2018, 2020, 2022) and good (2019, 2021, 2023) equity years have alternated at regular intervals in the recent past, this rhythm could be broken in 2024. This is at least indicated by the remarkable performance of the first few months, which - by historical standards - almost equalled the performance of an entire year and set new records for international equity indices (world: MSCI World - USA: S&P 500 - Europe: STOXX Europe 600 - Germany: DAX).
Source: LSEG Datastream, Colin&Cie
Long-term categorisation of equities
Compared to other asset classes such as bonds, precious metals/gold and alternative investments, equities offer the highest expected returns in a historical comparison. However, they are also associated with a higher risk, with an average fluctuation range of +/- 17 per cent and a maximum risk of loss of 40 to 50 per cent.
For this reason, equities are particularly suitable for long-term asset growth. With an investment period of more than 17 years, the probability of avoiding losses with equities and achieving the target return of 8 per cent annually is almost one hundred per cent. The diversification of equities across different companies, sectors and geographical regions has a supporting effect.
Assessment of the situation
When assessing individual financial markets and asset classes, we draw on various relevant valuation factors. Regarding the development of equity prices, these are:
a) Fiscal and money market policy: an expansive fiscal policy (increase in government spending, reduction in taxes) and money market policy (low key interest rates) are effective instruments used by governments and central banks respectively to stabilise/stimulate the economy. An expansive fiscal and monetary policy has a positive effect on equities.
b) Economic cycle and growth: A positive economic environment is a key driver for the successful development of companies. As shareholders of companies, shareholders benefit from their sales and earnings growth, whether in the form of dividends and/or share price increases. As a rule, the equity markets anticipate economic upturns and downturns with a lead time of around six months.
c) Valuation (price/earnings ratio): When valuing equities, the current price level is set in relation to company profits (P/E ratio). A high P/E ratio - in historical comparison - is to be interpreted as a negative indicator, as the share price is thus considered to be expensive and unattractive. On the other hand, a low P/E ratio in historical comparison should be interpreted as a positive indicator, as the equity price is considered favourable and attractive in relation to the profits generated.
d) Sentiment: A euphoric mood on the equity markets should be interpreted negatively, as it is usually the result of a recent sharp rise in prices and therefore indicates an exaggeration to the upside. An anxious mood among investors on the equity markets, on the other hand, should be interpreted as a positive indicator, as it is usually the result of a recent sharp fall in prices and thus points to a downward exaggeration.
e) Trend channel: Looking at the current equity price level in the long-term trend channel provides information on the extent to which it deviates from the long-term average. If there is a strong deviation from the trend line, exaggerations (high, unattractive price) as well as understatements (low, attractive price) can be recognised.
Outlook
The interpretation of the valuation factors described above forms the basis for our assessment of the development of the equity price level over the next six to twelve months:
a) Fiscal and money market policy: As the world's largest economy, the fiscal stimulus in the USA is creating a positive economic environment with corresponding economic growth in the country itself and beyond. According to data from the International Monetary Fund, fiscal policy support in the US should remain at an elevated level of 6 to 8 per cent of gross domestic product until at least 2028, regardless of the outcome of the presidential election (11/2024). In addition, the easing inflationary pressure in the US and Europe reinforces the prospect of falling key interest rates.
Source: LSEG Datastream, Colin&Cie
b) Economic cycle and growth: The further improvement in the global purchasing managers' indices (value < 50 => economic contraction; value = 50 => zero growth; value > 50 => economic growth) as leading economic indicators point to robust global economic growth over the course of 2024. Growth in the US should be particularly strong with a value of 55 by the end of the year. The economy in Europe may also improve, although with a value of 50 it will lag the US due to weaker fiscal policy support.
Source: LSEG Datastream, Colin&Cie
A comparison of the US equity market (S&P 500) and the US leading economic indicator (PMI) shows that the improvement in the US economy to a value of 55 has already been priced into equity prices. Based on the historical three-year economic cycle, if we assume that the economic environment will weaken again in the course of the fourth quarter of 2024, equities should then no longer find the same level of support as recently.
Source: LSEG Datastream, Colin&Cie
c) Valuation (price/earnings ratio): The positive economic environment and the prospect of falling interest rates will continue to form the basis for corporate profits at a high level in the USA. However, the strong earnings growth of American companies has led to an even stronger rise in equity prices. As a result, the P/E ratio of American equities has risen to 20.2. Compared to the valuation of equities in Europe (13.5) and the emerging markets (11.9), US equities are therefore expensive. The high valuation in the USA may lead to stronger corrections in the medium term, while equities in Europe and the emerging markets are more attractively valued and therefore tend to have fewer setback risks.
Source: LSEG Datastream, Colin&Cie
d) Sentiment: The very euphoric investor sentiment (chart: US private investors) should be interpreted negatively and could lead to equitiy price declines.
Source: LSEG Datastream, Colin&Cie
e) Trend channel: The stronger upward trend divergence of US equities (see chart) should limit their further performance potential. By contrast, equities in the emerging markets and in Europe, which are below or only slightly above the long-term trend growth line, have scope for further price increases.
Source: LSEG Datastream, Colin&Cie
CONCLUSION: Even if a continued expansionary fiscal and monetary policy can be assumed in the USA, the data on economic growth and economic growth shows that the equity market has already priced this into current prices. On the contrary, the indicators "valuation", "sentiment" and "trend lines" call for caution and point to limited price potential and an increased risk of setbacks in the medium term - particularly for US equities. Within equities, Europe is currently the most attractive region (economic recovery potential, lower short-term interest rates, declining inflation, attractive valuation, good market technology). This should be considered with a higher weighting in the portfolio.
Independent analyses by Colin&Cie
Our "Analysis of record equity prices" is an "independent research note". Its aim is to provide clients and non-clients alike with unbiased and comprehensible information on the current performance of the equity market and an assessment for the next six to twelve months.
To evaluate financial markets and asset classes, we draw on historical economic data, our own valuation models and over 250 indicators with objectively measurable criteria. With this purely fact-based approach, as an independent asset manager we deliberately distance ourselves from subjective or unverifiable forecasts resulting from media or other influences.
We publish our analyses and assessments in regular articles as well as in our quarterly publication "Assessment of the situation and outlook for the next 6 - 12 months" on the website www.colin-cie.com
Disclaimer - legal notice
This publication was produced by the Investment Office of the Colin&Cie Group. The information and opinions contained in this document are based on sources we believe to be reliable. However, we cannot guarantee the reliability, completeness or correctness of these sources. All information and quoted rates are only up-to-date at the time of this publication and are subject to change at any time without notice. The content is based on numerous assumptions made by the Colin & Cie Group. It should be noted that different assumptions can lead to materially different results. The forecasts and assessments are only current at the time this publication is prepared and can change at any time without prior notice. Past performance of an investment is not a guarantee of future results. Certain investments can experience sudden and substantial losses in value. This information and views do not constitute a solicitation, offer or recommendation to buy or sell investment instruments or to carry out any other transactions. We recommend interested investors to consult their personal advisor before making decisions on the basis of this document so that personal investment goals, financial situation, individual needs and risk profile as well as further information can be duly taken into account as part of a comprehensive consultation. The information contained in this publication is marketing material that is distributed for advertising purposes only.
