This blog is part of a new series on Institutional Investor entitled Global Market Thought Leaders , a platform that provides analysis, commentary, and insight into the global markets and economy from the researchers and risk takers at premier financial institutions. Our first contributor in this new section of Institutionalinvestor.com is AllianceBernstein, who will be providing analysis and insight into equities.
For investors of all stripes, the volatility in global equity markets last week was extremely unsettling. It’s not only the fear of a double-dip recession in the U.S. or a deepening fiscal crisis in Europe that’s making investors nervous. When markets are driven by raw emotion and sheer panic, the analytical tools we rely on suddenly seem ineffective.
But in times like these, I think it’s more important than ever for investors to stay focused on the long-term prospects of companies. That may sound counterintuitive when markets are being driven by macroeconomic fears and are ignoring corporate fundamentals. Yet there are many reasons to believe that recent market gyrations are creating exceptional opportunities that will eventually reward patient investors.
Many measures reflecting risk aversion are back at levels reached during the depths of the financial crisis. For example, stocks are very cheap compared with bonds. The dividend yield on the Standard & Poor’s 500 index is now 2.2 percent, the same as the yield on U.S. ten-year Treasuries. Excluding late 2008 and early 2009, the S&P 500 dividend yield hasn’t traded above the ten-year Treasury yield since the 1950s. Similarly, our models show that the U.S. equity risk premium is now 8 percent — its highest level since the late 1960s.
Global equity valuations are also provocative. The MSCI world index traded at 1.6 times book value on August 12. Before the market trough in early 2009, stocks had not been so cheap since 1985.
Of course, if we’re in for another deep financial and economic crisis, these valuations might appear justified. It would be foolish to deny that the risks have increased. But I think it’s equally simplistic to disregard the significant improvements to corporate metrics that we’ve seen over the past three years.
Nearly 60 percent of companies in the MSCI world index beat second-quarter earnings expectations, and more than 76 percent of S&P 500 companies did the same. Forecast return on equity for the companies in the MSCI world index was 15.3 percent at the end of July, compared with 12.0 percent at the end of February 2009. And after cutting costs, companies have built up massive cash balances, especially in the U.S., where cash as a percentage of assets is at its highest level since the early 1960s.
For current valuations to be justified, you would essentially have to believe that cash doesn’t determine value anymore. Even in the current environment, that’s a stretch too far for my imagination.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio management teams .
Kevin Simms is global director of value research at AllianceBernstein.
