AJ Bell press comment – 1 June 2022
- Markets are fearful, but not in panic mode
- A falling pound has cushioned UK investors from market falls
- Tech stocks have sold off, but valuations still look elevated
- CAPE ratio has moderated but is still high by historical standards
Laith Khalaf, head of investment analysis, AJ Bell:
“After a torrid spring, markets have witnessed a bit of a comeback in the last few weeks, but some indicators suggest that the market wobble might not be over. Clearly the lifting of COVID restrictions in China is a major boost for the global economy, but the world is still beset by energy and food price inflation, which is going to restrain consumer spending on non-essential items, and could cause further geopolitical unrest, beyond the crisis unfolding in Ukraine. At the same time central banks are raising interest rates, which is leading to a tectonic repricing of risk. As a result, the US stock market in particular has fallen considerably this year, and yet by some measures, it still looks expensive.
“Calling the direction of the market isn’t a particularly fruitful way to invest, unless you happen to own an uncharacteristically reliable crystal ball. In such times of heightened uncertainty, a regular investment plan comes into its own, because by drip feeding money into the market gradually, you smooth out the ups and downs, and if the market dips, your fresh investment buys in at lower prices. Right now though investors might well be wondering whether it’s time to be fearful, or greedy.”
How fearful are others?
“Warren Buffett tells us it is wise to be fearful when others are greedy, and greedy when others are fearful. So how fearful is the market right now? If you look at the VIX index, often referred to as ‘Wall Street’s fear gauge’, the answer is a bit fearful, but certainly not as panicky as the spikes in the index we saw at the onset of the pandemic and during the financial crisis. The index currently sits at 26, which is above the long-run average reading of 20, but significantly below the readings of over 50 we saw in 2008 and 2020. So market anxiety is elevated, but it is certainly not at fever pitch, which suggests this is not a moment of extreme fear which should prompt investors to be excessively greedy.
Source: Refinitiv
Markets so far in 2022
“The mood of anxiety rather than full-blown panic is also reflected in the performance of major indices so far this year. We have seen a correction in the US and European markets, and indeed amongst the mid and small cap companies on the London Stock Exchange. So far though this is a retreat rather than wholesale capitulation. The NASDAQ 100 is probably the exception to this rule, where rising interest rates have sparked a sell-off in some of the tech names which make up so much of this index.
“The performance of the FTSE 100 is notable amongst its peers, however, as the UK’s blue chip index has bucked the trend, and has eked out some positive performance this year. Partly this is of course due to the index’s high weighting to oil and gas companies, which have benefited from higher energy prices. However, a falling pound has also helped to buoy the sterling value of the international revenues which make up the lion’s share of FTSE 100 cashflows.
|
YTD return in GBP |
YTD return in local currency |
|
|
UK indices |
||
|
FTSE 100 |
4.5 |
4.5 |
|
FTSE 250 |
-12.3 |
-12.3 |
|
FTSE Small Cap |
-9.4 |
-9.4 |
|
FTSE All Share |
1.2 |
1.2 |
|
Overseas indices |
||
|
MSCI Europe ex UK |
-9.0 |
-10.1 |
|
MSCI World |
-6.2 |
-11.0 |
|
Nasdaq 100 |
-16.3 |
-22.0 |
|
S&P 500 |
-5.9 |
-12.4 |
|
TSE TOPIX |
-7.3 |
-4.8 |
Source: FE total return to 27/05/2022
“The pound has fallen from around $1.35 at the beginning of the year to $1.26 today, which has slipped under the radar a bit due to more worrying developments emanating from the Ukraine crisis. Analysts at Bank of America now say the pound faces an existential threat and draw parallels with emerging market currencies. These musings are not short on melodrama, but they do highlight the negative market sentiment towards the pound, which is being driven by a weak economic outlook, and the revival of tensions with the EU over the Northern Ireland protocol. The central bank in the US has also caught up with the Bank of England after the latter got a head start on raising interest rates, and the Fed is now expected to have more economic slack to tighten policy more aggressively.
“A weaker pound has been a silver lining for UK investors though, not only in the performance of the FTSE 100, but also of other overseas investments. The most popular investment funds now sit in the global sector, and most of these are benchmarked against the MSCI World index. As the table above shows, the MSCI World Index has fallen by 11% this year, but in pounds and pence it has fallen by just over 6%. A weakening pound has actually helped cushion UK investors from falling markets, particularly in the US.”
Tech sell off in perspective
“Clearly it’s the US which has shouldered the worst of this years’ sell-off in developed markets. If we look at the performance of the ten biggest stocks in the S&P 500, we can see why this is the case. Investors have sold down the big tech names which had thrived during the pandemic. Partly this is down to rising interest rates diminishing the appeal of the more distant cashflows provided by growth stocks, partly down to disappointing results from the likes of Meta and Snap, which have undermined confidence in the hitherto seemingly unstoppable progress made by big tech businesses.
“But while share price falls in 2022 have been quite savage, looking back a whole year many of these stocks are still in strongly positive territory. Tesla shares are down over 28% in 2022, but are still up over 20% since last May. This trend becomes even more extreme as we zoom out 2 years, or look back to the pre-pandemic period. So while share price falls in the tech sector have been quite extreme this year, so were share price rises at the back end of last year, and indeed, since the pandemic began.
|
|
% growth |
|||
|
2022 |
1 year |
2 years |
Since Jan 2020 |
|
|
Apple |
-15.7 |
19.4 |
88.2 |
104.0 |
|
Microsoft |
-18.8 |
9.6 |
50.3 |
73.3 |
|
Amazon |
-30.9 |
-28.7 |
-4.5 |
24.6 |
|
Alphabet |
-22.0 |
-6.1 |
59.1 |
68.7 |
|
Tesla |
-28.1 |
20.4 |
363.0 |
808.0 |
|
Berkshire Hathaway |
6.2 |
9.9 |
72.0 |
41.2 |
|
UnitedHealth Group |
1.0 |
22.8 |
66.9 |
72.5 |
|
Johnson & Johnson |
5.8 |
7.3 |
24.9 |
24.1 |
|
NVIDIA |
-36.0 |
21.5 |
121.0 |
220.0 |
|
Meta Platforms |
-42.0 |
-41.4 |
-14.8 |
-4.9 |
|
|
|
|
|
|
|
Average top ten |
-18.1 |
3.5 |
82.6 |
143.1 |
|
S&P 500 |
-12.8 |
-1.0 |
37.0 |
28.7 |
Source: FE, Sharepad, share price growth to 27th May 2022
“Indeed this can be seen in the shape of the performance chart for the US market as a whole, where falls over the last six months have simply erased gains made over the previous six months. This means anyone who invested in the US stock market a year ago is about evens on their investment, and those who invested two years ago have still made a lot of money. So only very recent investors will be feeling the pain when they look at their portfolio statements. Again, this suggests that what we have witnessed in the US market is a relatively light dousing of animal spirits.
Source: Refinitiv to close 27 May 2022
Tech valuations
Stock prices also need to be related to company earnings in order to give a rounded view of where market valuations are at. If we look at the current forward PE ratio on the biggest ten stocks in the S&P 500 index, we can see that a number of the largest tech stocks are trading below their five year averages, which suggests they are relatively cheap right now. However, there is a big question mark over whether tech valuations in the last five years represent an appropriate benchmark for comparison, or rather reflect a bubble ushered in by an era of cheap money and low bond yields. One also has to question whether earnings expectations might get trimmed, as consumer activity is dampened by inflation throughout this year.
|
Current forward PE |
5 year average forward PE |
Current v 5 year |
|
|
Apple |
23.3 |
20.8 |
12.0% |
|
Microsoft |
25.7 |
27.5 |
-6.5% |
|
Amazon |
72.2 |
82.5 |
-12.5% |
|
Alphabet |
18.7 |
25.8 |
-27.5% |
|
Tesla |
55.2 |
119.1 |
-53.7% |
|
Berkshire Hathaway |
22.8 |
21.4 |
6.5% |
|
UnitedHealth Group |
22.1 |
18.4 |
20.1% |
|
Johnson & Johnson |
17.2 |
16.4 |
9.1% |
|
NVIDIA |
32.4 |
39.4 |
-17.8% |
|
Meta Platforms |
15.2 |
23.4 |
-35.0% |
Source: Refinitiv as at 30th May 2022
CAPE ratio
“Looking at a longer term measure of market value, Robert Shiller’s CAPE ratio, it seems evident that despite the pullback, US shares are still trading at historically lofty valuations. The CAPE ratio currently sits at 32.5 times earnings, down from 38 times at the turn of this year, but that level has still only been eclipsed during the dotcom bubble of the late 1990s. The long-run average for the US stock market is a CAPE reading of 17, and even looking at more recent history, since the turn of the century it has averaged 27, which is still considerably lower than the current level.
Source: http://www.econ.yale.edu/~shiller/data.htm
“The CAPE ratio is only one measure of valuation, albeit an influential one. The ratio has historically been inversely correlated with US bond yields, so if interest rates continue to rise, the CAPE ratio will tend to fall, and in the short term that would seem more likely to happen as a result of lower stock prices rather than higher earnings. The CAPE ratio is also inversely correlated with subsequent ten year returns from the US stock market, which suggests that the lower the ratio when you invest, the higher your long-term returns. And of course, vice versa.”
CAPE Ratio versus US bond yields
Source: http://www.econ.yale.edu/~shiller/data.htm
“Investors who are buying the US market dip might well be proved right in doing so, but they should also be prepared for the possibility that the market wobble might not be entirely over just yet. Rising interest rates and the inflationary brake on global economic activity remain risk factors, even though over the long term equities offer investors one of the few ways to get a return above inflation. While there has been a sizeable correction in US stock prices, valuations still remain elevated, which suggests it’s not a time to be fearful, or greedy, but somewhere in between.”
