Recent economic data shows the continued trend of inflation on the increase and unemployment on the decrease. So what impact does this have on fixed income and equity markets ?
In particular, the market observes a sustained drive in employment (decline in unemployment) heading towards the 2008 lows around the time of the “sub-prime” financial crisis. At the same point in time, the market has seen sharp decline in bond yields with many government bonds currently yielding negative rates (in fact the iShares € Govt Bond 0-1yr index currently yields -0.51%, with the 1-3 year version of duration 1.75 years paying -0.05%).
Armed with the above, one therefore must question the benefit of owning fixed income assets in Europe.
The equity markets have also risen to new highs (as per other global indices) albeit on so far better earnings. However, one may point to warming up factors where shareholders in general become exposed to write-downs (aka oil at end of 2016, or indeed individual items like the recent Cobham write-downs which are systemic across all companies). The P/E ratio of the Core EURO STOXX 50 is 17.06X with a P/B at 1.59. The leading dividend benchmark (which consists of 30 stocks) is slightly better value at 14.71 & 1.36 respectively for p/e & p/b, potentially indicating a 16% discount on both global metrics. If investors want a breakdown of the composites, welcome to contact us here.
As a side note to the above, the value investor may well consider Europe as a better play given the same SPX500 is 21.15 & 3.05 respectively for p/e & p/b during what some have now termed the “Trump bump”. Some economists may even point to overheating on long term metrics.
On looking overseas, for fixed income, the market has already seen US rate hikes on the cards (3 rises talked about for this year) and a disparity in US yields relative to European where US 1-3 year index with a duration on 1.97 years yields 1.23% compared to the already discussed -0.05% for Europe. The markets have been fast to price this in, so potentially leaving a switch out of European fixed income into US fixed income (or European equity).
What conclusions can one draw ?
- Possibly that high dividend Euro Stoxx are the best play (at least on pure valuations terms).
- European fixed income (especially the short end) offers little value, whereas US fixed income has some value.
- The US Equity indices are higher on valuation terms so may have the largest downside in the long term (assuming market reversion to historic multiples) compared to European equity.