Markets hit high
As indices in western markets regain past loses and march upwards it might be time to ponder and view the results in the light of current news on housing and the growth of interest rates across many of these markets – this article in BN provides a good succinct overview.
Markets hit new highs, but why – BN
Yesterday it was the FTSE’s turn. The Dow Jones has been hitting new highs with such regularity, that it’s no longer news. The FTSE 100, on the other hand, is still 715 points short of the all time high of 6930.2, set on the last day of the last millennium, but it’s getting closer. Ten days ago it passed the five year market high, that had previously been set in May, which meant it had recovered from the spring crash in just a few months. Since then, it has risen a further 51 points. It’s not the heady stuff seen in the US, where the Dow is now more than 400 points above the former all time high of 11722 set on January 14 2000 (and which had remained as an elusive record for over six years until early October). Even so, it’s still a good run, and who knows, the FTSE could hit a record by the year’s end. But the question is this: when the US economy is expected to slow, and when the UK economy is doing okay, but by no means booming above trend, why are the markets so strong?
In part, of course it’s down to corporate results, which are doing very nicely. But maybe there’s more.
In the long term, shouldn’t there be a relationship between a company’s profitability and earnings and the rate of interest? Remember, the rate of interest just offers a yield, say 5 percent. If a company is generating a profit in excess of five percent of its market valuation (so that’s a pe ratio of 20), that company should represent an attractive alternative to a cash investment. But take into account that you would expect the profitability to grow each year – then the equity investment should win hands down.
And yet, in recent years, while the rate of interest has been low (it’s still relatively low in historical terms), pe ratios have been relatively low too. You would perhaps have expected the opposite.
BDO Stoy Hayward produce some definitive data on historical pe ratios. And they show that, in the second quarter of this year, the average pe ratio for a non financial company, at 14.4, was the lowest level for at least nine years. (The data available doesn’t go back any further).
The charting web site Trade 10 indicates that typical pe ratios for the Standard and Poor 500 are at their lowest this decade.
Combine this with data showing that the money supply is growing, and perhaps you can begin to understand why private equity acquisitions are all the rage.
And, as often as not, company acquisitions, whether they are private equity, or corporate, such as the impending takeover of Corus by Indian company Tata, often involve borrowing to fund the deal against the assets of the company they are buying. How can they do this? Because the rate of interest, relative to the pe ratio, is low.
Maybe this, in part, builds upon the carry trade, which is based on the idea that the excess liquidity sloshing around the economy at the moment has its routes in Japan, where the rate of interest is much lower. So people borrow in Japan and lend elsewhere.
So, while company valuations are soaring, the pe ratios are not.
But take a different perspective and, instead of examining quoted companies, have a look at unquoted businesses.
If you are looking to sell your company, you may be interested to know that typical pe ratios for unquoted companies sold, is now approaching a record. According to BDO Stoy Hayward, this ratio is now 14.4 – it has been higher, hitting 14.7 in 2000 – but, that aside, it’s the highest level seen since 1997.
As ever the markets seem to contrive to confuse all that seek to understand them. We take a more pessimistic view on the world, some may say bearish, but sometimes the dials on the rev counter point to red, some of us get a thrill out of pushing the red line, some of us want to be here in 10 or 20 years time.