After a roller-coaster first half of 2020, now seems like a good time to review the CAPE ratio for the FTSE 100, FTSE 250 and, for US-focused investors, the S&P 500.
FTSE 100 CAPE ratio review
The FTSE 100 has had a tough time over the last few years, largely thanks to the eurozone crisis of the early 2010s and, since 2016, Brexit. This has kept FTSE 100 valuations relatively low compared to historic norms.
More specifically, the FTSE 100’s CAPE ratio has been below average* since the market crash of 2008/2009.
*The FTSE 100’s average CAPE for the last 30 years is just over 18. However, that period includes the largest bubble in UK stock market history (the dot-com bubble) so I prefer to use the slightly more cautious figure of 16.
In keeping with these generally low valuations, the FTSE 100 entered 2020 at a price of 7,450 and with a CAPE ratio of 15.6, slightly below that average figure of 16.
Soon after that we ran head first into a global pandemic and the stock market reacted exactly as an experienced investor would expect.
Fear and panic led to a record-breaking collapse of share prices, followed by a quick rebound driven by a more pragmatic revaluation of long-term earnings expectations.
At the moment of maximum panic (March 23rd) the FTSE 100 fell below 5,000, a level first reached in August 1997, almost exactly 23 years ago.
When prices decline the CAPE ratio also declines, and with the FTSE 100 at 5,000 in March that gave the large-cap index a CAPE ratio of 10.3.
10.3 is significantly below the average CAPE of 16, suggesting that the FTSE 100 was likely to be very good value at that price.
To put that into context, the chart below shows the FTSE 100 against the normal range of possible CAPE valuation levels. It’s a range which extends from half to double the long-term average CAPE of 16.
The March 2020 low of 5,000 is clearly towards the bottom end of that valuation spectrum, implying there was little downside risk and much upside potential, at least from a valuation point of view.
Another way to think about the relationship between CAPE and future returns is to look at earnings yields instead of PE ratios. In other words, invert CAPE to turn it into a cyclically adjusted earnings yield figure, or CAEY:
Cyclically adjusted earnings yield = 1 / CAPE * 100%
March 2020 FTSE 100 CAEY = 1 / 10.3 * 100% = 9.7%
The earnings yield is a bit like the interest rate on a savings account. Of course, earnings can go up and down, but a 9.7% “interest rate” is still a very attractive starting point by historical standards.
Earnings which are not retained by companies are typically paid out as dividends, and in March the FTSE 100 had a dividend yield of 6.6%, more than double its long-term average of around 3%.
So regardless of whether you look at CAPE, cyclically adjusted earnings yield or dividends, one thing stands out:
At the moment of peak fear in March the FTSE 100 seemed to offer very good value.
Since then, the market has rebounded and as I write the FTSE 100 has recovered to 6,280. That’s a return of almost 26% in just four months, which is pretty good going by any reasonable standard.
This should not come as a surprise to value investors. After all, the fundamental principle of value investing is that high valuations (think dot com bubble in 1999) tend to produce low returns and low valuations (the recent panic in March 2020) tend to produce high returns.
Despite much gnashing of teeth over whether value investing still works or not, that fundamental principle has not changed one tiny bit.
At 6,280 today the FTSE 100 has a CAPE ratio of 13, which is slightly below the average of 16. Given that slightly low valuation, I would say this:
- The FTSE 100 is probably slightly cheap and is therefore somewhat likely to produce slightly above average total returns (where average is around 8% annualised) over the next five to ten years. If the index rose to “fair value” tomorrow it would grow by 24%.
FTSE 250 CAPE ratio review
The FTSE 250 has had a much better run over the last few years than the FTSE 100, having quadrupled in price from late 2008 (the depths of the credit crunch) to the start of 2020 (just before the pandemic set in).
Over the same period, the FTSE 100 barely doubled.
However, despite this impressive performance, the FTSE 250’s CAPE ratio has remained close to its historic average of 22 for most of the last ten years.
That was still true in the run up to the pandemic, where the FTSE 250 entered 2020 at a price of 21,880 and with a CAPE ratio of 24.
That’s slightly above average, but only slightly, so the implication is that the FTSE 250 was close to fair value at the beginning of 2020.
When the pandemic struck, the FTSE 250 was hit every bit as hard as the FTSE 100. In fact it was hit harder, possibly due to its higher starting valuation, with the mid-cap index falling more than 40% in about a month.
That was nothing more than blind panic, but it left the FTSE 250 at 12,850 and with a significantly lower CAPE ratio of 14. You can see this dramatic decline in the chart below.
14 is a long way below the “fair value” of 22, so the CAPE ratio was clearly suggesting that in March 2020 the FTSE 250 was likely to be very good value at a price of less than 13,000.
A CAPE ratio of 14 is equivalent to a cyclically adjusted earnings yield of 7%, so investing in the FTSE 250 in March was a bit like putting money into a savings account with a 7% interest rate. Equities are higher risk of course, but a cyclically adjusted earnings yield of 7% should give you some idea of just how attractively valued the FTSE 250 was at the time.
If you like to value investments by their dividend yield then the FTSE 250’s yield at that time was an impressive 5%. That’s not quite as high as the FTSE 100 but it’s still very good for an investment which has more than doubled its dividend over the last ten years.
As with the FTSE 100, the FTSE 250 appeared to be attractively valued precisely when investors were at their most fearful, so being greedy when others are fearful is more than just a cute Buffettism.
After the panic subsided the FTSE 250 recovered to a more reasonable level. As I write it sits at 17,230, giving those who sunk additional capital into the market in March a handsome gain of 34% in just four months.
As I’ve said before, good returns from low valuations should come as no surprise to value investors.
With the FTSE 250 at 17,230 it has a CAPE ratio of 19. That’s slightly below the “fair value” level of 22, so I would say this:
- The FTSE 250 is also probably slightly cheap, therefore mildly above average total returns (where average is around 10% annualised) are somewhat likely over the next five to ten years. If the index rose to “fair value” tomorrow it would grow by 15%.
S&P 500 CAPE ratio review
While the FTSE 250’s four-fold increase in price from 2008 is impressive, the S&P 500 can trump that with a near five-fold increase between the credit crunch of 2009 and its pre-pandemic all time high in early 2020.
That’s an incredible run, especially as capitalism was apparently on the brink of collapse in 2009.
After that record breaking ten-year run, the S&P 500 entered 2020 at an all time high of 3,260, a miraculous feat of expansion from its 2009 intra-day low of 666 (no, 666 is not a typo, it really did bottom out at that ominous number).
Through early 2020 the S&P 500 just kept on growing, reaching its current all-time high of almost 3,400 in February.
At that price the S&P 500 had a CAPE ratio of almost 32, which is nearly 80% above the 100-year average CAPE ratio of 18.
And then of course then pandemic panic began, wiping 35% off the US large-cap index in just a few weeks.
35% sure does sound like a big fall, but given the S&P 500’s lofty starting valuation it wasn’t even enough to take the market back to “fair value”, let alone anything that could be called cheap.
The moment of peak panic came in March, just as it had for the FTSE indices. For the S&P 500 the panic left it with a much reduced price of 2,240 and a CAPE ratio of 20; lower, but still above the 100-year average of 18.
To me this shows an astonishing degree of optimism.
Despite the world facing its first major pandemic in over 100 years, despite many countries telling their citizens to not go to work, not go to the shops, not to leave their homes, investors were still more optimistic about US companies than they had been, on average, over the previous 100 years.
And as if that wasn’t enough, as soon as the panic subsided investors, traders and speculators bid up US stock prices to the point where today the S&P 500 sits at 3,260, fractionally higher than it was at the start of the year and just 4% below its all time high.
In other words, Mr Market thinks the pandemic and its related global recession (“the worst economic downturn since the Great Depression“) will effectively have a net zero impact on the future earnings of the S&P 500.
This apparent disconnect between US market valuations and global economic conditions has led some notable investors to the conclusion that the US is very likely in a 24 carat solid gold stock market bubble.
Quoting someone who is considerably smarter than me:
“My confidence is rising quite rapidly that this is, in fact, becoming the fourth, real McCoy, bubble of my investment career. The great bubbles can go on a long time and inflict a lot of pain but at least I think we know now that we’re in one. And the chutzpah involved in having a bubble at a time of massive economic and financial uncertainty is substantial.”
Jeremy Grantham, billionaire value investor in an interview with CNBC
I’m not sure I’d call this a bubble just yet, but from a CAPE valuation point of view the S&P 500 is definitely in the somewhat hot zone, which is surprising given the extreme levels of uncertainty. And if the pandemic does take a sledgehammer to earnings over the next couple of years then yes, this could well be a full blown bubble.
When asked about the exposure investors should have to US stocks, Grantham said “I think a good number now is zero”.
That might be a bit extreme, but the army of armchair traders created during lockdown won’t listen anyway, because when you’re in a bull market, everyone thinks they’re a genius.
Given the S&P 500’s relatively high CAPE ratio of 30 compared to its 100-year average of 18, I would say this:
- The S&P 500 is probably expensive and therefore likely to produce materially below average total real returns (where average is around 9% annualised) over the next five to ten years. If the index returned to “fair value” tomorrow it would decline by more than 40%.
Great post, great analysis. Do the potential returns you’re quoting include inflation?
As for the SP500, how high would you like it to go before you’re certain it’s a bubble? 4000? 5000? 100000? It looks ripe for popping to me right now. I’d be surprised if it returns an average of 3% annual over the next decade including inflation.
Personal note, picked up some more FTSE 100 at just under 5000, and a lot more 250 at 40% below the high. Wish I’d bought more!
Hi IIN
Potential returns: I’ve just updated the average nominal return figures to 8% for the FTSE 100, 10% for the FTSE 250 and 9% for the s&P 500. It’s important to remember that these are averages and returns over any given decade can be much higher or lower than average.
S&P 500 bubble price: My definition of a true bubble is that CAPE is about twice its long-run average, and the S&P 500 will reach that point when CAPE is 36, which would occur if the price today was about 4,000. That’s about 23% above where it sits today. If earnings over the next couple of years are decimated as a result of the pandemic then the S&P 500 may already be in a bubble.
There’s a lot of anecdotal evidence suggesting it’s very bubble-like already. A good example is that a senior Blackrock quant apparently said that “comparing share prices to fundamentals like corporate profits or book value is essentially futile in complex markets”. In other words, valuation doesn’t matter, which are the three scariest words in investing:
https://www.financial-planning.com/articles/blackrock-quant-sees-stock-valuation-a-mystery-not-worth-solving
As for S&P forward returns, according to CAPE it’s about 40% above fair value, so that’s a 40% headwind which is easily enough to offset earnings growth for the best part of a decade. As always though, we’ll have to wait to see how this all pans out.
Hey John. Nice definition of bubble. By almost any other metric (Price to book, Stock market value to GDP etc) the US is pretty much bubblicious. As the poster below says, glad I’m not overexposed to it! Looking at what is happening right now, if the FED can keep all these plates in the air it will be miraculous. It’s almost as if they think they can ‘legislate prosperity’.
Love the ‘scariest quote’ – I’ll use that in future!
Any thoughts on Emerging markets? I’m tempted but keep remembering that the usual funds (like HMEF) are just a few percent from all time highs, and the countries in the index include Brazil and India, covid nightmares unfolding…
I think it’s probably good to have some exposure there. In my case it comes through some of my more international holdings, but I don’t deliberately try to invest in emerging markets through funds.
Interesting. What would you say to the idea that the FTSE 100 is actually an international large cap index? After all, the companies in it do most of their business outside the UK…
I’d agree with that. The FTSE 100 gets about 75% of its revenues from outside the UK so international exposure is already pretty much built into it. I haven’t seen any breakdown of exactly where those non-UK revenues come from though, so whether they’re heavily exposed to any one other country (e.g. the US) I have no idea.
So… March 2021. Time for an update on the FTSE? They’ve done me proud since last year…
Yes, a UK market valuation article is very overdue.
Unfortunately I made the mistake last spring of buying up too many companies. Valuations were low so I added quite a few new holdings, but this has now bit me on the backside as I have to re-review all these companies when their annual results come out. And as it’s results season, I have a tsunami of detailed reviews to do!
Once I’ve cleared up the backlog of annual reviews I’ll get on with doing another UK CAPE review, probably in late March or early April. I’ll also review the S&P 500 as valuations there are much more interesting (and by “interesting” I mean very high by any normal standard!)
John, I think the significant valuation differences in the markets you have illustrated could be attributable to where the companies are and the industries they play in.
It is true that social media., the cloud, global online shopping, advanced internet search, electrical automotive industries, semiconductor IP, have massive future market TAMS.
The S&P dominates all of these markets.
The FTSE has nothing in this space and neither does Europe – especially since ARM was sold to Softbank in the UK’s case, and in Europe it seems Wirecard was a scam in the one large fintech that Germany held — the rest of the industries are being slowly and possibly soon to be rapidly superseded.
Hi LR, that is indeed the bull case. Tech is creating a “new economy” and will eat the “old economy”. Valuations don’t matter. All that matters is likes, shares, eyeballs and network economics.
For anyone older than 30 that all sounds very similar to the late 90s tech bubble.
So while there are undoubtedly a lot of high quality tech businesses in the S&P 500, there are also a lot of fantasy land valuations as well. And while tech is important, people and the economy need steel, copper, heavy machinery, buildings, clothes, food and lots of other non-tech stuff as well. So I don’t see the “old economy” going anywhere anytime soon.
John, I guess the difference between the two periods is that all of the companies in the spaces I mentioned apart from Tesla are hugely profitable, have very high return on assets and are cash rich (hugely cash rich in the main).
The DotCom bubble was based on valuations on compabies with very few sales and no profits, and very weak balance sheets — the two periods are like chalk and cheese.
The benefit of the big players now is they consistently buy up all the future profitable ideas and expand their market shares.
I agree. Investors’ current love affair with “quality” companies looks more like the Nifty Fifty than the Dot Com bubble:
https://www.stewartinvestors.com/en-gb/education/lessons-from-the-past-the-nifty-fifty/
I would add that company valuations need to be viewed in the light of very low interest rates, which are likely to be in place for several years if not longer.
If 10 year treasury yield is 0.55%; that implies a PE of 180
investors are being pushed further out on the risk curve
The complete absence of any inflation means that central banks have no reason to raise interest rates – and in fact the greater risk is deflation due to lack of demand
Another point to bear in mind is the huge distortion on the S & P 500 index of the major tech companies; if these companies are excluded, then many S & P stocks have rebounded, but are flat
Whether you like it or not, as the recent round of Q2 earnings releases demonstrates, these big tech companies have high rates of return on their assets and generate huge amounts of cash – and will likely continue doing so
Contrast that with the FTSE 100, where there have been dividend cuts at the banks and big oil companies
Hi Nicholas
Yes, I agree there are lots of valid reasons why the S&P 500 would be on a much higher valuation multiple.
However, there have always been valid reasons why a market might be trading at a particularly high or low CAPE ratio, and ten years later most of those reasons have unwound and the index has reverted back to normal levels. Therefore my expectation is that this time will not be different and that the S& P 500 is likely to have weak returns over the next decade or so as CAPE reverts to more normal levels.
Hi John
We shall see
I am not going to pretend to be able to see where the market will be in 10 years time
However current global trends are clearly favouring the companies making up the Nasdaq rather than those in the FTSE100
If the trends change, I will adjust my portfolio accordingly
The fact that the S & P may have weak returns over the next decade is not a valid reason in my opinion not to participate in the stronger returns available in the US market at the moment
The CAPE argument about asset allocation assumes that all stock markets and their underlying economies are the same – and they are not; thus for me, using CAPE as a tool to decide where and when to invest is likely to mean not investing in the strongest markets
But as usual everyone has to find a method of investing which allows them to sleep at night!
Hi Nicholas
I don’t want to argue the toss, but I just want to clarify this:
“The CAPE argument about asset allocation assumes that all stock markets and their underlying economies are the same”
This isn’t really true as most CAPE valuations are based on that specific market’s historic average CAPE ratio. So for example the S&P 500 CAPE is compared to that index’s long-term average CAPE. Of course, it’s possible that the US economy has switched permanently into a low inflation high growth economy, and therefore can justify higher CAPE ratios effectively ‘forever’ (say the next few decades), but then again it might not, in which case CAPE is likely to revert to its mean when the current high levels of growth taper off.
It’s interesting to note how desperate the US government is to shut down every major threat from Chinese companies at the moment. Of course, that won’t work for long as China has many times more highly educated engineers than the US, so Chinese tech domination in the near future is a almost a foregone conclusion in my opinion. But I’m not a geopolitical analyst, so my opinion doesn’t count for much.
Hi John,
Great article. My question is as follows. We had a rebound from the lows and you indicate that based on CAPE the FTSE 100 is reasonable value/cheap based on historic CAPE. However, how can one believe any of the future earnings presented. Most companies have not disclosed future earnings and those that have are not necessarily correct as we are not in a steady state market environment (or should I say typical market environment),
In summary, is the true earnings being taken into account. I agree that good value companies will prosper in the long run but I struggle to see how one can conclude that as the current CAPE is below the average CAPE they are good value. Particularly as everyone is finding it very difficult to “predict” future earnings.
Hope That makes sense and really do appreciate your work.
Best regards,
Richard
Hi Richard,
Predicting future earnings is hard at the best of times let along in the middle of a global pandemic, so I understand your point.
However, while earnings in any given year may be unusually high or low, when averaged out over a decade (CAPE is based on ten-year average inflation adjusted earnings) they tend to follow a reasonably predictable pattern of steady increases over time. In other words, average earnings over the next ten years are likely to be similar to (and probably slightly higher than) average earnings over the last decade. That is effectively the earnings prediction that I make when using CAPE.
So yes, predicting earnings for most companies is very hard and perhaps impossible in a pandemic, but the law of large numbers (averaging together earnings from hundreds of companies over ten years) allows us to predict future average earnings (and therefore whether index prices are low, high or fair) with a useful if imperfect degree of accuracy.
If I’ve worded that badly and it doesn’t make sense just let me know.
Very informative and interesting article which has certainly made me wonder if my global allocation is positioned correctly.
I follow a passive strategy where my global allocation is set to the world weighting as – “this is where the markets/experts have placed their money and doing any differently I would be saying I know better than the market.“
However, with the USA accounting for 57% of the global market coupled with the high Cape values and predicted low growth as mentioned in your article I am beginning to seriously wonder whether I should break the passive rules and reduce the USA over the next 10 years.
Hi Keith
This is a very interesting point. If you’re a full on 100% passive investor then the idea is that you just stick with it no matter what, because (in theory) even if we’re in a bubble it’s impossible to consistently beat the market by fiddling with allocations and so on.
However, there is a way to reduce exposure and take profits whilst staying 100% passive. The answer is to rebalance assets back to your desired allocation.
So for example, if a passive investor had £100k in stock trackers in 2009 and £100k in bond trackers, then by now that might be £300k in stocks and £150k in bonds (those aren’t supposed to be accurate numbers). The passive way to dial down risk is to just rebalance back to your target allocation, in this case 50/50. So you would sell some of your best performing assets, in this case stocks, and use that to buy more bonds. This automatically tends to lead investors to sell expensive assets and buy cheaper assets, and this sort of diversification plus rebalancing is often called the only free lunch in investing.
If you want to start adjusting your allocation targets based on valuation (i.e. have more in stocks when they’re at low valuations and less at high valuations) then that’s active investing, and you need to be very careful before making the giant leap from passive to active as it’s like opening a potentially bottomless can of worms…
Thanks john I always enjoy reading your analysis.
Glad I’m not over exposed to the US market.
Thanks Dawn, glad you enjoyed it. I think some US exposure is fine and I have some through UK listed companies that operate in the US, but the US market and US tech stocks in particular seem to be going through a “novice day trader” boom thanks to lockdown combined with a ten-year bull run.
For example, one of my holdings is a platform for traders and speculators and it’s seen a massive spike in new clients and the number of trades placed by new and existing clients.
On the premise that many World stock-markets – including the FTSE are fairly valued or a bit cheap but the S&P is very expensive, does that help a U.K. value investor? My point and worry is that, if and when US stocks crash 40%+, won’t it pull down the other markets, just as it always has in the past? I don’t feel that I’m protected as much as I should be by being invested in solid, well run businesses in the U.K., Europe and Asia. Have you any words of comfort?
Hi Michael
I think the link between US and UK stocks is something of an old wives tale (apologies if that is no longer a politically correct phrase).
Yes, there is some correlation, but over meaningful time frames (years) it’s pretty weak.
For example, since 2009 the US market has increased five-fold and is now more than twice as high as it was in 2000 and 2008. The FTSE 100 is actually below where it was at the 2000 and 2008 market tops, so there has been little correlation between the two over the last decade.
If the S&P 500 fell by 50% then it would be only slightly below fair value. If the FTSE 100 also fell 50% (in “sympathy” with the US) then the FTSE 100 would be at 3,200 with a CAPE ratio of less than 7 (far lower than at any time in the last 30 years) and with a dividend yield of 10%.
So while there is no way to guarantee that the FTSE 100 won’t follow the S&P 500 down, if there was a significant decline from here it would leave the UK market at an astonishingly low level and with an astonishingly high dividend yield and equally astonishing potential upside.
That’s about as much comfort as I can give.
Hi John, what are your thoughts on some allocation in a value investor’s portfolio being made To Bitcoin?
On the 28th July there is a Webinar on this very topic sponsored by Blockworksgroup.
Type blockworksgroup bitcoin value investor into google and it will be the top result
I have no connection with the company I just happen to be a long term follower of your writing on value investing who is also fascinated by the long term potential of crypto. I am slowly making back my TED losses with it 😁
Hi Colin
Sorry but I don’t have any thoughts on cryptocurrencies. I think the blockchain idea is fascinating, but I haven’t had anything like as much time to read up on it as I’d like so for now I’m just an interested bystander.
Interesting read, it gives context. I think your portfolio was semi mechanical (rule based) so do you ignore the CAPE or change allocation in light of it?
How do you calculate the CAPE, and does it take into account negative PE or just the positive? Would it be possible to use cyclically adjusted net cash flow instead of the PE? How would one source such figures? So many questions…
Hi Robbins, lots of questions there!
“do you ignore the CAPE or change allocation in light of it?” – I use CAPE to give me an insight into where the market could go over the medium-term (5-10yrs). Obviously we can’t know in detail what will happen, but if the market was on a high valuation multiple then at least I would be psychologically prepared for the likely fall in value. I think adjusting cash weightings based on CAPE is reasonable and perhaps even sensible, but I don’t do it personally. I just stay 100% invested in equities and try to invest in quality companies at value prices, even if the overall market itself is overvalued (which in the UK it hasn’t been since 2008).
“How do you calculate the CAPE” – CAPE is the ratio of current price to ten-year average real (inflation-adjusted) earnings. It would take into account negative earnings if they ever occurred at the index level.
“Would it be possible to use cyclically adjusted net cash flow” – Yes, if you could get hold of the data. I don’t know of any data provider that has index cash flow data, so you’d have to build it up from the individual companies (e.g. the 100 companies in the FTSE 100).
Earnings is much easier because you can calculate earnings from the index’s PE, and the current PE is available here:
http://markets.ft.com/Research/Markets/DataArchiveFetchReport?Category=&Type=GWSM
Hi John,
I wanted to add a different angle to your article a historical context. If you look at the South Sea Company and Mississippi Company both were marketed with untapped growth and wealth opportunity. This drove share price to unrealistic levels until it burst.
The scariest thing is we now have companies like Apple worth $2 trillion or Amazon with a PE ratio of 135 and the worst Tesla which never makes a profit but has a market cap of $400 billion. In the background most rationale people can see that we are in due for a massive economic fallout due to COVID-19. Due to globalisation we have an integrated economy so if one country sneezes we all catch a cold.
Under such circumstances market price should be down not up and yet the market is going up whilst global GDP is contracting. I feel extremely nervous. Personally I think 2008 was not so bad because it was a financial crisis i.e. we can all shop and travel as we like.
Now we face an existential crisis where physically normal activity is no longer possible. To put it frankly if a person can’t work they can’t earn money they can’t buy goods/service in turn a company has reduced revenue leading to reduced profit leading to reduced employment and tax it generates for a state. Ultimately if a state can’t generate tax revenue it means it can’t run a nation.
Ultimately it seems like a lot of countries are almost becoming like communist states. Printing money to keep a country going. I say that because COVID-19 has affected pretty much everyone around the world so no country is any good shape to lend to another country. Yet the market is up. In the future the market activity of this period may be compared to other strange events like Tulip mania.
Hi Reg, I agree.
However, at least the crazy valuations are mostly in the US and mostly in the tech sector, so there are still lots of companies available in the UK at what appear to be sensible or even attractive valuations.
I agree that this is very likely to turn out to be a true blue bubble, although of course it’s impossible to know when it will burst (perhaps when the army of new lockdown day traders have to sell to buy bread?)
Hi John,
The craziest thing is that its not just tech stock but any company with strong fundamentals are marked at such elevated price there is some serious mismatch between reality and market expectations.:
1) KONE listed in the Finnish stock market is one of the dominant companies in the elevator/escalator business. Price is at all time high, except with social distancing I would have expected to share price of KONE to actually fall down as office and public space are the biggest market? Even the update given by management is someone of sombre nature yet the share price matches on.
2) Estee Lauder another all time high stock according to the market on the other hand management have reported loss, axing of jobs due to closure of concessions which make a large contribution.
3) LVMH my all time favourite stock reported a massive drop in the first half of the year and yet the stock remains buoyed. This is a company that depends on international travel to grease its profit engine.
To me it seems that all of these companies have strong long term fundamentals but one has to question whether the price is a fair price let alone undervalued. I can list so many other quality companies with PE in the range of 40+.
My only explanation is those dratted tech stocks. Since they have been elevated to levels irrational exuberance quality companies have benefited from this irrational valuation system.
Yes, “quality” and tech are very much in favour at the moment. I still think there’s a lot of reasonably valued companies in the UK market though.
Value wins in the end. When a ‘phone maker’ is worth more than the entirety of the FTSE 100, one has to take a step back and go… er… er… er… no thanks. What’s happening right now in the States is gambling (or ‘speculating’, to use a less pejorative word) pure and simple. At some point soon, pop goes the weasel, and the whole S&P comes tumbling down, because it’s being held up by nothing but ‘tech’ (phones are ‘high tech’? A glorified yellow pages is ‘high tech’? Where’s my hover board? Now THAT’S ‘high tech’ 🙂 JOHN, any suggestions as to why the rest of the world has slavishly followed the Yanks, but the UK hasn’t? Do you think it’s purely a ‘Brexit’ discount, and if so, how justified is it?
I think the UK market got hit by the eurozone crisis in 2012 or thereabouts, then Brexit in 2016, so it lost its recovery momentum after the financial crisis. Plus it doesn’t have any meaningful tech weighting.
So It doesn’t have momentum and it doesn’t have growth tech, both of which are in favour at the moment.
For international investment managers I’d imagine it’s hard to sell clients on the idea of investing in the UK when Tesla seems to double every few weeks.
Hi John + Investing Internationally, Naturally. says,
There is another reason why FTSE 100 has under performed relative to S&P 500, most of the FTSE 100 is made of mediocre companies which wouldn’t pass the quality test. Looking at the list these are the companies I would say that have some form of moat:
AstraZeneca, BAT, Burberry, Diageo, Experian, GSK, Reckitt Benckiser, RELX, Smith & Nephew and Unilever.
All of these companies not only have an international focus they happen to dominate their sector against other international companies. They have a cumulative market cap of £562 billion which translates into a third of the net worth of FTSE by only 10 companies! This helps expose the underlying weakness of the FTSE 100 it is populated by mediocre companies or those companies that dominate in sector that have poor returns on your capital.
I think any fund manager who wants to invest in companies with an international focus is some what limited by the number of quality companies available in FTSE 100. On the other hand the S&P 500 is a honour roll call of some of the best companies you can invest in the word. The only problem is the price you have to pay.
Apple for example is more than a phone company its a software company the iPad for example can be adapted for various business use. The same can be said for the Apple Watch or iPhone. The current pandemic has shifted online medical consultation I can see in the future that we may have watches that can track our health vitals and Apple would be the one which can capitalise on that. However this wouldn’t be growth income rather replacement of what it loses on current product. Therefore Apple is a very good company but not at current price which is purely speculative!
Hi Reg
I sort of half agree, but I’m wary of the FTSE 100 = BAD S&P 500 = GOOD narrative which has existed for quite a while. It’s true to a limited extent, but as you say the issue with the obvious “quality” companies in the US is price, as well as a lot of recent speculation (just look at the recent volatility in US tech recently).
So yes, there are some obvious quality companies in the US, but they’re obvious, so I’d say much of it (too much of it?) is already in the price.
Hi John,
As we speak I literally am sitting on the fence watching the market doing some rather peculiar movements. When we talk about valuation, currently we have a situation where stock prices PE ratio exceed that of stocks before the crash of 2008. Therefore I expect a lot of people will be burnt by the market.
Two examples that come to my mind are Microsoft and Coca-Cola. Both took 16 years to recover. This acts as a stark reminder that even quality has its limit.
However just my opinion I think the FTSE index may end up like the Japanese stock market i.e. dead money. We lack sufficient number of companies with durable competitive advantage to help a buy and hold investor like myself. This has forced me to take an international approach to look for quality companies. I would also like to say for a quality company with plenty of growth potential and high ROIC a PE ratio of 20 to 30 isn’t absurd.
Unfortunately all the quality companies I can think of are nearing to 60+. I read seeking alpha and if that is representative of private investors it sounds awfully like speculation for me.