Alarm bells are they ringing?

As we enter the ninth year of the equity bull run post the 2008 financial crisis, one of the longest in history, it may be worth looking at some comparisons of market valuations between then and now. Robert Buckland, head strategist at Citi has compiled a series of such valuation matrix across several asset classes we can use.

The first is the CAPE, or cyclically adjusted price earnings to give its full title, otherwise known as the Schiller p/e after its creator. The measure adjusts the price earnings ratio of the S&P 500 over a ten-year period adjusted for inflation. The current CAPE is 27, just below the 29 it reached in 2008.

Price to book ratio is the next measure Robert considers, this is calculated by taking the stock market value and dividing it by its book value. According to Star research global price to book is 1.9 times, which is below the 2.6 at the end of the previous cycle. According to the same research house the current price to book of the US equity market is at 2.8, high relative to history. Merrill Lynch calculate the current book value of developed markets to be 2.1.

Dividend yield is the next measure, at the end of the last cycle it was 2.2%, for global equities. According to Merrill Lynch this figure is 2.6%. Considering where global bond yields lie, this continues to make equities look attractive.

The yield curve defined by the yield on the 10-year treasury minus the yield on the 2-year treasury. At the end of the last cycle this was less than half of percent. Currently the 2 year US treasury yields 0.76 and the 10 year 1.55, a difference of 0.79%. Tighter than at the start of the year where it stood at 1.22%, but above the 0.5%.

Global earnings per share is the next measure, at the start of the last crisis earnings were expected to fall by more than 20%, current expectations for 2016 are a modest growth in earnings year on year.

The level of Corporate activity is the next alarm bell Robert looks for, and after a bumper year last year this year both mergers and public offerings remain below levels of 2007.

Net debt/ebitda ratio is the next. At the last peak it was 1.4X. This is a measurement of leverage, calculated as a company's interest-bearing liabilities minus cash or cash equivalents, divided by its earnings before interest, tax, depreciation and amortization. 

Finally, the yield gap between high yield and US treasuries. The gap that can cause concern is when it rises to between 6-7%, suggesting higher risk debt is in danger of defaulting. Currently the gap is around 5%.

The conclusion is it’s a mixed picture, but at present despite the fall in bond yields driving equity valuations higher. Currently a few of the measures may be flashing amber, but not too many have yet turned red yet. 

Posted on August 23, 2016 .